Per expectations noted last week, the Federal Reserve kept the fed funds target rate steady at the FOMC meeting on Wednesday. After three straight rate cuts, Chair Jerome Powell is looking to set a baseline for economic activity to guide future rate adjustments.
Will historically low interest rates persist?
In the past few weeks, Fed officials have expressed their satisfaction with the state of the economy. Following the three recent rate cuts, Jerome Powell stated before congress that he was happy with the current economic indicators.
Powell also stated that it would take a “significant move-up in inflation, that’s persistent” before the committee would consider changing course and raising rates. Therefore, it seems The Fed is content in continuing with its “wait-and-see” approach to monetary policy.
Interest Rates Seem Stable for the Moment
The Fed endured a market mini tantrum the last time rates were raised, back in December of 2018. Powell admitted that the economy was not as strong as what was initially thought and indicated that there were some inaccuracies in the data. The committee has since revised their estimates for the current neutral interest rate and have adjusted rate targets accordingly.
Now that The Fed seems more comfortable with the economic indicators, it is reasonable to expect that rates could remain steady in the near-term. However, keep in mind that the end of 2018 brought some market action that few analysts saw coming, so it would be wise to pay close attention to markets as they prepare for year-end.
What is to be expected the future for interest rates?
The labor market shocked analysts when it returned a monthly job growth number of 266,000 in November, beating estimates by over 100,000. This may be a sign that the labor market is not as tight as policy makers think, and that there is still room for future employment gains.
Fed critics are worried that central bankers estimated the natural rate of unemployment to be too high, leading to unnecessary tightening last year. One estimate predicts that if the Fed had raised rates slower since 2016, or not much at all, GDP could have been 0.4-0.8% higher and 530k to 1 million more people could have been employed.
Currently, the Fed’s median projection for interest rates in the year 2020 is unchanged from the current fed funds rate. Officials have been revising long run unemployment downward for years, and it currently stands at 4.1%, significantly lower than projections of almost 5% just four years ago.
In response to the perceived mistake last year, the Fed appears ready to keep rates lower to foster maximum employment gains. Their projections predict slower and modest GDP growth over the next few years, with unemployment little changed and inflation increasing towards the 2% objective. These projections support their expectations for continued low rates.
The Repo Market
In mid-September, the repo market made headlines as the overnight fed funds rate spiked significantly outside the Fed’s upper bound. Some believe this was exacerbated by a lack of available cash from a large sale of treasuries to primary dealers in conjunction with seasonal corporate tax payments, which reduced the availability of cash for many organizations. The repo market is often referred to as the “plumbing” of the financial system, and any disruptions there are likely to ripple throughout different financial markets.
Since this issue arose, the Fed has been purchasing bonds to increase the amount of cash in the system. Some have called this another round of QE, and opinions differ on that categorization. Due to the expectation that the biggest banks will be looking for cash to meet regulatory reserve requirements, there is fear of a potential market event near the end of this year. Powell stated in a press conference following the rate decision that the Fed is ready to “adjust our operations as appropriate”. This is an issue that all market participants should watch closely.
What can we expect from interest rates going forward?
Rates have the potential to move in both directions in the coming months. Given the slight uptick in global growth and manufacturing, and the White House inching ever closer to a trade deal with China, there is potential for upward movement. On the flip side, manufacturing is still in recession, and just as one trade dispute gets resolved there seems to be another that arises. Considering this uncertainty, it seem the markets will need to follow in the Fed’s footsteps and “wait-and-see”.
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