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Fed's new theme is patience, likely setting up pause for near-term hikes


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Fed's new theme is patience, likely setting up pause for near-term hikes

Federal Reserve officials signaled this week they may pause, at least for now, their gradual interest rate hikes as they evaluate the extent to which the economy is weakening.

The week featured a heavy dose of Fed news, including the minutes of the December 2018 meeting, appearances from the central bank's top two and speeches from three of the new voters on the Federal Open Market Committee.

The officials expressed varying levels of worry over the economic outlook, listing uncertainties such as trade tensions, weaker global growth and tighter financial conditions as points of concern. But they agreed the Fed has the flexibility to hold off on further interest rate hikes as they examine whether incoming economic data is pointing to worrying signs.

That, some analysts say, likely sets up a pause in Fed rate hikes for much of the first half of 2019. For example, BMO Capital Markets analysts now see the Fed raising rates only twice instead of three times — and those rate hikes coming in June and December, rather than earlier in the year.

Below are some early takeaways from analysts on the Fed's plans for this year:

*Patience is the new mantra: Fed Chairman Jerome Powell soothed stock markets Jan. 4 when he said the central bank "will be patient" as it tightens monetary policy.

He struck the same tone again in a Jan. 10 appearance, saying the Fed is "waiting and watching" to see whether downside risks end up weighing on economic data. That followed the release of the Federal Open Market Committee meeting minutes from December, which said many Fed officials believe they can "afford to be patient" on further interest rate increases.

And if there was any doubt on the new message, Fed Vice Chairman Richard Clarida declared in a Jan. 10 speech that "patience is a virtue and is one we can today afford."

Andrew Brenner, Natalliance Securities' head of international fixed income, wrote it is "hard to believe this is the same Fed" that raised interest rates in December 2018, when some analysts had warned a rate hike was unnecessary and could add to turmoil in the markets.

*Inflation pressures contained: If the Fed is emphasizing patience, it is largely because there is little sign that inflation will jump significantly above the Fed's 2% goal anytime soon, analysts say.

The latest evidence came Jan. 11, when the U.S. consumer price index report showed the CPI dropped 0.1% in December 2018 from the previous month, largely due to a fall in gasoline prices. Meanwhile, the Fed's preferred inflation gauge — the core personal consumption expenditures price index — rose 1.9% on an annual basis in November 2018, up from the previous month's gain but still below the Fed's 2% goal.

"With inflation right where the Fed wants it to be, policymakers will be able to take a breather from raising rates in [the first quarter] as they assess the extent of the imminent slowdown in growth indicators," CIBC Capital Markets economist Katherine Judge wrote after the latest CPI release.

Top Fed officials also do not appear to be concerned that a recent pick-up in wages might push up prices substantially, to the point where the Fed will have to raise rates to keep inflation in check. Clarida, for example, said Jan. 11 that the wage increases are welcome and that they "are not, at present, a source of upward, cost-push pressure on price inflation."

One of the Fed's most dovish members, St. Louis Fed President James Bullard, again cautioned against raising rates again in a Jan. 10 speech, saying lower inflation expectations are a "market signal that the current stance of monetary policy may be too hawkish." Bullard rotated into a voting spot on the FOMC this year.

*Some upside potential remains: But Fed officials are open to the possibility that the clouds hovering over the economy may fade.

That includes Chicago Fed President Charles Evans, who said Jan. 9 that if downside risks subside, he expected the Fed to eventually set its benchmark rate "a touch above its neutral level." Surpassing the so-called neutral interest rate would mean the Fed begins to hold the economy back following more than a decade of monetary stimulus.

Evans, along with fellow FOMC voter Eric Rosengren, both said the Fed has some flexibility in the near-term in its decision making.

But Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote to clients that they should not "ignore the warning from Evans" on the potential for future rate hikes from the Fed.

If trade tensions between the U.S. and China ease and investor confidence over the economy picks up, the Fed "will have to start signaling" that they may begin slowing growth a tad, he wrote. That would help ensure labor markets do not tighten too much and cause inflation to heat up.

Lindsey Piegza, Stifel's chief economist, also wrote that Fed officials have been "somewhat resistant to acknowledge early signs of weakness in the domestic economy" and have instead largely pointed to slower growth abroad. That, she wrote, means that a March rate hike "is still on the table."