Federal Reserve officials are moving into a more unpredictable phase of policy-making after two years of removing economic stimulus in regular, quarterly intervals.
They will be deciding whether and when to raise interest rates more on the basis of the latest signs of economic vigor—such as in inflation, unemployment and growth—and less on forecasts of how the economy is expected to perform in the months and years to come, they’ve indicated in interviews and public comments.
This could mean increased uncertainty for markets about the likely path of interest rates more than a few months or even weeks ahead.
Most Fed officials in September penciled in one more rate increase this year, which is expected when they meet Dec. 18-19. But their outlook for next year is wide open: They were roughly evenly split between whether to raise rates two, three or four times.
This phase follows many years in which the policy path was more straightforward. The Fed held its benchmark federal-funds rate near zero for seven years after the financial crisis, an extraordinary period of easy money aimed at supporting the wobbly recovery. Policy makers lifted the rate once in 2015 and once in 2016, as the expansion firmed.
As the economy strengthened, they continued tightening policy, hitting a quarterly stride in 2017. They have raised the rate three times this year, most recently in September to a range between 2% and 2.25%.
This has moved the rate closer to a level most officials expect is appropriate for a healthy economy, a so-called neutral setting designed neither to spur nor slow growth. Many Fed officials see this at around 2.75% or 3%.
But because they aren’t sure where neutral lies, they are looking for clues in markets and economic data that might suggest whether this point might be higher or lower.
Fed Chairman Jerome Powell recently compared the task to walking through a room full of furniture when the lights go out. “What do you do? You slow down. You stop, probably, and feel your way,” he said at an event earlier this month. “It’s not different with policy.”
The Fed is raising rates to prevent the growing economy from fueling excessive inflation or dangerous asset bubbles.
“Raising rates too quickly could unnecessarily shorten the economic expansion, while moving too slowly could result in rising inflation and inflation expectations down the road that could be costly to reverse, as well as potentially pose financial stability risks,” said Fed Vice Chairman Richard Clarida in a speech Tuesday.
Fresh economic data should determine not only how the Fed’s rate-setting committee plots individual rate moves at each meeting, but it should also produce regular reappraisals of two key policy signposts, he said. The first is the neutral rate of interest, and the second is the unemployment rate consistent with stable inflation.
The process of learning more about the two estimates, said Mr. Clarida, “supports the case for gradual policy normalization, as it will allow the Fed to accumulate more information from the data about the ultimate destination for the policy rate.”
Mr. Powell also noted the risk of relying too much on data that are revised frequently and that can be slow to flag shifts in the broader economy. He said he also likes to consider anecdotal reports from businesses that convey a sense of the economy’s strength.
“You pick things up sooner talking to business people because they start to feel it, and then it shows up in the data,” Mr. Powell said.
The new phase carries some risks for investors seeking to understand the Fed’s intentions. Last month, for example, Mr. Powell rattled markets when he played down the debate over whether the Fed would raise rates above neutral, saying the concern was premature. Rates are “a long way from neutral at this point, probably,” he said at an event in Washington.
Even though the substance of Mr. Powell’s comment largely reflected many Fed officials’ public projections, some analysts said his tone reflected greater conviction to raise rates. That contributed to a bond-market selloff that was already fueled by strong U.S. economic data boosting expectations of Fed rate increases. Rising bond yields, in turn, helped send the stock market on a wild ride last month.
Officials have ample opportunities in coming days to clarify how recent market turmoil has affected their economic outlook. Mr. Powell speaks in New York on Wednesday and testifies on Capitol Hill next week. New York Fed President John Williams speaks on Friday.
Another factor making the Fed’s policy-setting less predictable in 2019 is its increased flexibility to adjust rates eight times a year, instead of four, because Mr. Powell will convene a press conference after every meeting. In recent years, the Fed made major policy changes only at meetings followed by news conferences, which occurred quarterly.
“All meetings are live now. There’s no question about it now,” Mr. Powell said earlier this month.
The biggest source of policy uncertainty is the U.S. economy itself. Although most Fed officials expect it to slow next year, they don’t know how smooth or bumpy the process will be, and how the economy will react to the continued withdrawal of monetary stimulus.
Already, rising interest rates have slowed the housing sector.
The recent drop in oil prices could hold down inflation and curb business investment in the energy industry. Mr. Clarida said Tuesday that one indicator of investors’ expectations of future inflation appeared to be falling short of the Fed’s 2% target.
The pace of global growth is projected to slow next year, and trade tariffs could pose even bigger headwinds for U.S. exporters.
Meanwhile, in the U.S., one key tailwind is set to fade because recently enacted federal spending increases expire in less than one year.
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