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UPDATE: Fed opts for dovish rate hike but signals no pause in tightening

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UPDATE: Fed opts for dovish rate hike but signals no pause in tightening

The Federal Reserve raised its benchmark interest rate for a fourth time this year and signaled a less aggressive approach in 2019, though it showed few signs of pausing its tightening.

The unanimous decision from the Fed puts its target for the federal funds rate at 2.25% to 2.50%, with the Federal Open Market Committee saying in its post-meeting statement it "judges that some further gradual increases" in interest rates are likely necessary.

Fed officials shifted down their views on the number of interest rate hikes in 2019, with officials now penciling in two hikes next year, down from a September projection of three increases. The downward shift in the projections came amid growing risks to the U.S. economic outlook in 2019, partly due to ongoing trade tensions, signs of slowing global growth and a lift from the U.S. fiscal stimulus potentially fading.

SNL Image

Jerome Powell, chairman, Federal Reserve
Source: AP file photo

Fed Chairman Jerome Powell acknowledged those risks in his news conference, along with some of the recent volatility in the markets. The Fed chief said "some crosscurrents have emerged" since Fed officials last put out their projections in September. But he said most Fed officials still see the U.S. economy performing well in 2019, an outlook that means "policy at this point does not need to be accommodative." Still, he added, Fed policy is "not on a preset course" and will shift according to conditions on the ground.

"We will adjust monetary policy as best we can to keep the expansion on track, the labor market strong and inflation near 2%," Powell told reporters at the conference.

He also did little to signal the Fed was looking at taking the monthly cuts to its $4.1 trillion balance sheet off auto-pilot, saying he does not "see us changing that" and that the trimming is proceeding smoothly.

U.S. stocks dropped after the Fed decision, with the Dow Jones Industrial Average falling 1.49% to 23,323.66. That suggests a more dovish tone from the Fed "wasn't enough for the stock market, where investors appear to have been hoping to see a more substantive change in the Fed's tone," wrote Ian Shepherdson, chief economist at Pantheon Macroeconomics.

But the major message from Powell was that the Fed's shift toward data dependency is continuing, Shepherdson and other analysts said, which could push policy in either a more or less aggressive stance depending on how economic figures come in.

Powell said there is a "fairly high degree of uncertainty" among officials about their policy path going forward. That is partly because the Fed has "reached the bottom end of the range" of views they hold of the neutral interest rate, when the Fed would neither be giving the economy an extra boost nor holding it back.

As it approaches neutral, Powell added, Fed officials must pay even closer attention to shorter-term economic data.

"From this point forward, we're going to be letting the data speak to us and inform the outlook," Powell said.

The projections from the Fed show officials expect the U.S. economy will grow by 3% for all of 2018 and drop down to 2.3% in 2019. The latter projection shifted down from the September estimate of 2.5%.

Inflation, meanwhile, has slowed and been below the Fed's 2% goal for the past three months despite an unemployment rate of 3.7%. Fed officials are projecting that inflation will stay around the Fed's target for the next few years, which gives the Fed "the ability to be patient" on future rates hikes, Powell said.

Some analysts warn that outlook may not play out. The labor market "is primed to give the Fed a bloody nose" and force it to raise rates four times next year, assuming that trade tensions between the U.S. and China ease, Shepherdson wrote.

John Ryding, chief economist at RDQ Economics, wrote that he also sees growth coming in above the Fed's expectations and that a lower unemployment rate would push inflation up to 2.2% next year.

"In these circumstances, we would expect a data dependent Fed to deliver more rate hikes than two," Ryding wrote.

Others see the Fed sticking to two rate hikes in 2019, or perhaps fewer.

Michelle Meyer, U.S. economist at Bank of America Merrill Lynch, wrote the Fed is "showing greater hesitance in moving rates above neutral." Tighter financial conditions are becoming a headwind for the economy, and weaker business investment figures will lead to slower GDP growth in 2019, she wrote.

Stifel Chief Economist Lindsey Piegza projected the Fed would only raise rates once more in 2019 amid the "deteriorating reality" of recent economic data.

"While the Fed doesn't appear poised to take a pause just yet, the sense of immediacy to ramp up rates has clearly waned with officials acknowledging an economic picture of reduced growth and slower inflation," she wrote.