On the Middle Ground Stands Mr. Powell

“We are trying to take the middle ground,” said Fed Chairman Jerome Powell when asked about his rates strategy. No surprises and no drama during his first news conference after last week’s Federal Reserve Open Market Committee (FOMC) meeting. Indeed, Mr. Powell found the middle ground between the doves and the hawks.

Last week the FOMC increased the Fed Funds target rate by 25 bps to 1.50-1.75%, and the committee indicated the Fed Funds rate is on a higher track as the economic outlook has strengthened. The committee predicts 3 hikes this year and 3 rather than 2 hikes for 2019. GDP growth is now expected to be 2.7% in 2018, up from an expectation of 2.5% as recently as December, and the unemployment rate is expected to fall to 3.8%, slightly lower than the previous forecast of 3.9%. This rate would be the lowest since the 1960s and well below the Fed’s revised 4.5% estimate of full employment. Even inflation is expected to be a little higher, as the 2019 forecast for core PCE inflation was increased to 2.1% from 2.0%. This is a tiny increase, but important as the Fed is signaling it finally expects inflation to rise above its 2% goal.

Of course, Fed expectations and projections are data dependent, including for the course of inflation, slack in the economy, and other items like the impact of trade policy.  

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The market reaction to the committee’s actions was muted. Ten-year rates fell 2 bps to 2.88%, banks increased their prime lending rate by 25 bps to 4.75% and 3-month LIBOR rates continued their climb, now reaching 2.27%. As recently as last year, 3-month LIBOR was only 1.15%. We expect these increases in short term borrowing rates may even push up bank deposit rates. In recent months the average deposit rate has begun to creep higher, led by big online banks. 

Balancing economic growth and modest increases in interest rates is tricky business, and the middle ground is safe. Welcome to the podium, Mr. Powell, and please stand firm in the middle!

Sources: The Federal Reserve, Bloomberg, the Financial Times, Wall Street Journal, the New York Times.