Resisting "Rescue me!" pleas from equity markets, the Federal Reserve (Fed) followed through on previous guidance with a rate hike at the December 19th meeting. Highlights from the Fed's statement, meeting and Chairman Powell's press conference include:
The federal funds target range was raised 25 basis points (bps) to 2.25% to 2.50%
The Interest on Excess Reserves was raised 20 bps to 2.40% - a move designed to push the federal funds rate closer to the mid-point of the target range
The Dot Plot median forecast for 2019 dropped to two rate hikes from three
2019 Gross Domestic Product growth outlook was lowered to 2.3% from 2.5%
Balance sheet roll-off will remain capped at $50 billion per month
The Fed added language it "will continue to monitor global economic and financial developments," elevating market volatility as a factor in policymaking decisions
Powell emphasized policy will be driven by incoming data and neither pace nor destination is pre-determined
While the move was expected by most investors, there was more uncertainty around the outcome of this meeting than any in recent history. Wednesday morning, federal funds futures placed only a 70.8% probability of a rate hike - generally there is more unanimity on Fed meeting days. December's miserable equity market performance, wider credit spreads and reduced liquidity have tightened financial conditions, prompting increased calls from investors and economists for the Fed to pause the tightening process.
After spending the past few months arguing against the Fed's aggressive forecast for three rate hikes in 2019, I found myself in the awkward position of urging the Fed to follow-through with the December rate hike. To a point, I was advocating for our book, as we strived to position portfolios for this hike. But I also believed such a dramatic retreat from previous Fed outlooks due primarily to market volatility would, in the end, sap rather than bolster investor confidence.
Ultimately, I think the message from the Fed was less dovish than markets hoped, particularly keeping language around "some further gradual increases" rather than inserting the more neutral "further adjustments." Otherwise, Mr. Powell carried a reasonable tone and the Fed accomplished several objectives: 1) The federal funds rate was moved closer to neutral in a low unemployment environment, 2) The Fed gave itself more room to maneuver in 2019 by moving off a regimented pace toward more data dependency, which should better allow the Fed to consider current market conditions, 3) The Fed made the point policymakers focus on economics and will not be swayed by the President's ubiquitous, public rebukes, and finally (and perhaps most importantly), 4) Mr. Powell avoided jumping onto the treadmill of creating a Powell Put.
Despite today's policy tightening, the risk of an overly aggressive Fed tightening policy - in our view the primary threat to continued economic expansion - has been reduced.
FOMC Statement, December 19, 2018
FOMC Statement, November 8, 2018
FOMC Press Conference transcript, December 19, 2018
FOMC Projection Materials, December 19, 2018
FOMC Projection Materials, September 26, 2018