America’s expansion is more than robust enough to merit another quarter-point increase in interest rates by the Federal Reserve on Wednesday. But with global markets on shaky ground and growth slowing in Europe and Asia, the outlook for 2019 is murkier.
The Fed will announce its latest rates decision at 2pm Eastern time, and Jay Powell, the central bank’s chairman, will discuss the reasoning at a press conference half-an-hour later. The meeting will be especially closely watched, even by Fed standards, given signs that the central bank is ready to slow the pace of rate rises in 2019.
What will happen to rates?
The target range for the federal funds rate will probably be boosted for the fourth time this year (and the ninth time since the Fed started increasing rates in 2015), taking it to 2.25-2.5 per cent. The steady reduction in the size of the Fed’s balance sheet will probably continue.
There has been some speculation that recent market turmoil could prompt the Fed to shelve the December move, but that remains unlikely. The US economy is expanding at a brisk 3.5 per cent annualised pace, unemployment remains at its lowest levels since the 1960s at 3.7 per cent and wage growth is accelerating. Suddenly dropping plans for a quarter-point increase could send a panicky signal to markets.
However, the overall message from the meeting is likely to point to a more cautious Fed in 2019, in part because interest rates are getting closer to “neutral” settings that neither stimulate the economy nor hold it back. Core inflation has also remained tepid, at 1.8 per cent, lessening the pressure for more rate rises.
What will the Fed’s statement contain?
The Fed will probably give a sanguine assessment of US economic performance, which has remained broadly resilient even as overseas economies, including Germany and Japan, dip into negative growth.
However, the statement may indicate a less predictable policy outlook next year. The Fed has now sent multiple signals suggesting it wants to get away from offering detailed policy guidance in its statement and shift to a more improvisational phase where it is reacting to incoming economic data.
Part of this new “data dependent” mode is a change to the language in the Fed’s post-meeting statement that could happen as soon as Wednesday. Throughout 2018, the central bank been telling traders that it expects “further gradual increases” in rates, but it may drop that steer as soon as this week’s meeting.
This would tell traders that the period of reliable, quarterly rate rises is at an end, and it could suggest a pause is possible early next year. Exactly what replaces the wording remains to be seen, but the possible amendment reflects in part the fact that after a procession of increases, rates are edging towards “neutral” territory, leaving it less obvious what comes next.
What will the Fed’s forecasts show?
The Fed’s dot-plot of officials’ rates forecasts — the subject of endless fascination on Wall Street — will be particularly market-sensitive this time around. The central bank’s median forecast in September was for another three quarter-point rate rises in 2019. But the markets are not even fully pricing in one single move next year.
Many analysts are expecting the median 2019 rates prediction to be trimmed, perhaps to two increases from three. Part of the reason is the recent sell-off in markets, which has tightened overall financial conditions. This may prompt a slightly softer set of growth forecasts, even if the overall economic outlook remains benign — with above-trend growth and inflation remaining near the Fed’s 2 per cent target.
Among the other key factors to watch are Fed forecasts for the longer-term interest rate, which stood at a median estimate of 3 per cent in September. If this edges down, it would be taken as a dovish signal, suggesting rates are closer to neutral than previously thought.
What message will come from Mr Powell?
Mr Powell tacked in a dovish direction in a market-moving speech in New York last month, after an earlier interview in October gave markets the impression that the economy was strong enough to merit multiple aggressive rate increases. The chairman is likely to be questioned on the reasons behind his more cautious tone, in which he stressed there is “no preset path” for policy.
The key questions in traders’ minds will be how close the Fed is to ending its rate-lifting cycle, and whether a “pause” is possible in March 2019. Mr Powell may also be asked about the possible “downside” risks to the recovery. These could include churning financial markets, the danger of worsening trade tensions with China, over-indebted corporate borrowers, weakening overseas growth, fading fiscal stimulus and the economic drag from successive rate increases starting in December 2015, alongside the Fed’s balance-sheet reduction programme.
Fed forecasts in September showed its interest rate rising above its longer-term level, in a sign that some officials saw policy becoming more restrictive to limit the danger that the economy overheats. Given recent market turbulence and tepid inflation, there seems less demand for Mr Powell to telegraph an appetite to clamp down on the economy.