Powell Maintains A Dovish Stance, As The Fed Remains In The Sidelines

Unlike last year’s contentious FOMC meeting in December, this year’s rate decision was uneventful, as the Federal Reserve kept rates, as markets expected, unchanged. Looking forward, the Fed’s dot plot points towards no change in interest rates in 2020 and a single rate hike in 2021. However, I wouldn’t put much faith in this projection for three reasons:

1. The dovish stance by Fed Chair: In the press conference, following the FOMC’s latest statement, Chair Powell didn’t close the door on further rate cuts in 2020. He kept acknowledging that the labor market, while strong, still does not show signs of overheating. At times during the press conference, he wasn’t clear about his take of the U.S. labor market, but the main takeaway seems that he still thinks the labor market still has slack even as unemployment is at 3.5%.

And as for inflation, he noted that both wage growth and headline inflation aren’t a cause for concern, for now. In recent months, wage growth has stabilized while inflation has been declining. These data only make a case for the Fed to avoid raising rates and allow it to lower rates in case the economy starts to slow down.

Source of data: FRED

Chair Powell seemed willing to entertain the notion of lowering rates in case of the first sign of trouble. These signs are not limited to disappointing economic data but also include a deterioration in financial conditions or fallout in the trade talks between the U.S. and China.

2. The Fed’s dot plot poor projection performance: Chair Powell stated that “properly understood” the dot plot is a useful tool. However, history hasn’t been kind to this policy tool. In fact, the dot plot (see table below) has almost always overshot (with the only exception being 2018: when the Fed’s rate outlook in 2017 was lower than the rate reached in 2018) its projections by an average of 0.85 pp since 2016. Therefore, while the markets are paying close attention to the Fed’s dot plot, it is essential to remember that their outlook is too hawkish.

Source of data: Federal Reserve

3. Headwinds ahead for the markets: While a trade deal between the U.S. and China could be made – and thus reducing the systemic risk in the markets – it remains a possible concern for markets. Moreover, weak investments and slower global economic growth could reach U.S. shores next year. Under these circumstances, the Fed will try to avoid a recession as interest rates are already below 2%. In the past, the Fed lowered the federal funds rate by 500 bp; this time, the Fed doesn’t have that option. Therefore, the Fed may execute additional “insurance rate cuts,” as it did this year.

On the one hand, the Federal Reserve isn’t expected to change policy in the near term. On the other, Jay Powell isn’t likely to wait long before lowering rates. Especially if the U.S. China trade war escalates or if economic data fall short of the Fed’s expectations. For the stock market, this “Powell Put” could offset some of the adverse effects a renewed trade war may have on it. However, if global slowdown or weak investment spending becomes a more significant issue for the U.S. economy, it will make the Fed’s job harder. In this case, the Fed may have to combat these problems without resorting to new unconventional monetary policies.