A Wait-and-See Approach
- The unanimous decision by the FOMC to keep rates unchanged this week was widely expected, but the committee’s increased caution regarding the outlook reaffirmed its wait-and-see approach to monetary policy.
- In other news, the Leading Economic Index for February suggests economic growth will continue, but with the positive contributions to the index getting smaller on trend, the index suggests a moderation in the pace of growth.
A Wait-and-See Approach
The two-day meeting of the Federal Open Market Committee (FOMC) was the focal point this week, concluding with a unanimous decision to keep the range of the federal funds rate unchanged between 2.25% and 2.50%. This decision was widely expected by financial markets, but the committee’s increased caution regarding the outlook reaffirmed its wait-and-see approach to monetary policy.
Perhaps expected, equity markets gained at the onset of the announcement, but markets soon gave back most of those gains after fully digesting the breadth of the FOMC’s decision. The committee downgraded its assessment of the economy, with officials’ median projection for growth this year dropping to 2.1% from 2.5% previously. With this more reserved outlook, the committee scaled back its expectations regarding tightening and now looks to be on hold for the rest of this year. Does this suggest the FOMC believes it has reached its neutral policy rate? Taking the dot plot at face value would suggest there is still a modest preference to hike rates 25 bps next year. But, given the patient tone of the FOMC and its data-dependent approach, it is remains a close call on if the next move would be a hike or a cut.
Our most recent forecast looks for the Fed to hike rates 25 bps later this year. Markets had previously priced in a low probability of a hike this year, but after this week’s meeting the tone among markets shifted, with the market implied probability of a cut in late 2019 jumping to about 60%. Although a rate hike in 2019 is still possible, the committees’ communication this week suggests that the risk to our forecast is skewed to the downside. We have been looking for a step-down in growth this year for some time now, and as highlighted in the committees’ statement, more recent data around consumer spending and business fixed investment suggest such a moderation in growth will unfold. For more detail regarding the FOMC decision, please see our Interest Rate Watch on page 6.
Besides the FOMC meeting, we also learned that the Leading Economic Index rose 0.2% in February. While the index continues to suggest a solid pace of growth, the positive contributions to the index have been getting smaller on trend suggesting some temperance. This is clearly seen in the interest rate spread component, as the spread between the 10-year Treasury and fed funds rate has continued to fall, although it has not fallen into negative territory. If—or perhaps when—the yield curve inverts, market apprehension of a recession will heighten. But, while we look for growth to moderate, we think financial markets may be underestimating near-term growth.
Both upside and downside risks to the outlook persist. Perhaps one of the largest of these risks remains the outcome of trade negotiations between the United States and China. A new round of talks are set to take place in Beijing next week, with the hopes of a deal by the end of April. But, President Trump said this week that tariffs on Chinese goods may remain in place for a “substantial period of time,” which only increases uncertainty around the impact to economic growth. We will continue to monitor these developments as they arise and adjust our forecast as necessary.
Housing Starts • Tuesday
Next week, we get a look at the extent to which the Fed’s dovish pivot has fed through to the housing market as we enter the spring buying season. The announcement of the “pause” in December spurred a 50 bps plunge in mortgage rates, which appears to have been just in time to stem the slide in residential activity, as housing starts rebounded 18.6% in January after the 14% drop in December. The jump in single-family starts last month broke a string of four consecutive declines. With permits running 15% ahead of starts, we expect to see a continued modest rebound through the spring.
Moderating home price appreciation and firming mortgage applications and builder confidence should boost new home sales, for which we also receive February data next week. As a primary transmission mechanism for monetary policy, the housing market will be closely watched this spring for clues as to the efficacy—and sustainability—of the Fed’s new stance.
Previous: 1,230K Wells Fargo: 1,201K Consensus: 1,210K
Consumer Confidence • Tuesday
Consumer confidence stabilized last month as the government shutdown and the equity market sell-off retreated further in the rear view mirror. While off the peak of 137.9 from last October, the index reading of 131.4 remains elevated amid a very strong labor market and accelerating wages. As financial markets and consumers digest the Fed’s new policy stance, their expectations for future conditions will drive the outlook for personal consumption.
Such elevated readings of consumer confidence are consistent with robust growth in personal consumption, which explains our surprise at the 0.6% drop in real spending reported in December. We caution against reading too much into t