The Fed: Rate Hikes Take a Hike in 2019

The U.S. Federal Reserve indicated that it expects no tightening moves in 2019. But that doesn’t mean rate hikes are off the table in the years to come.

On the first day of spring, doves were sighted at the U.S. Federal Reserve (Fed). The Federal Open Market Committee (FOMC), the Fed’s policy-making unit, left interest rates unchanged at the conclusion of its two-day meeting on March 20, 2019. In a set of projections released at the end of the meeting, Fed policymakers’ consensus expectations indicated that they do not envision any more hikes in 2019, down from expectations of two in December 2018.

In its post-meeting statement, the FOMC said the U.S. labor market “remains strong” but economic activity has slowed from the fourth quarter. Policymakers noted that inflation remains low, and “measures of longer-term inflation expectations are little changed.”

Following the Fed’s announcement, major U.S. equity indexes moved higher on March 20. A further announcement that the central bank would end the drawdown of its bond holdings in September sent benchmark Treasury yields to the lowest level in more than a year, according to a Bloomberg report.

Summing Up: Still Some Risk of Higher Rates

The Fed delivered a slightly dovish message on March 20, offering the following:

1. An ever-so-slightly downbeat assessment of the global economy compared to January.
2. Forecasters’ rate expectations—the famous “dot plot”—were cut modestly.
3. Word that the Fed’s balance sheet runoff will end in September, a bit sooner than expected.

However, the Fed also signaled a larger than expected “equilibrium” balance sheet—the size it intends to maintain in the long run, i.e. when it stops letting maturing securities roll off and instead replaces them with new purchases. (Note that since the Fed intends to return to an all-Treasury balance sheet eventually, this means maturing mortgage securities will be replaced with Treasuries.) Coupled with its expectation of a longer period of low rates (even if it’s only slightly longer), the signs coming from the FOMC are definitely dovish.

Having said that, we think the risk scenario is still tilted towards higher rates. Not a single Fed forecaster among the dot plot contributors expects any rate cuts through the end of 2021. And six expect one-to-two rate hikes in 2019, 10 expect one-to-four rate hikes by 2020, and 12 expect one-to-five rate hikes by 2021.

Chart 1. Connecting the Dots on the Direction of Fed Policy
Federal Open Market Committee assessment of appropriate fed funds rate, 2019–onward (as of March 20, 2019)

Source: U.S. Federal Reserve. The “dot plot” is a statistical chart consisting of data points plotted on a simple scale. Each shaded circle indicates the value (rounded to the nearest 1/8 percentage point) of an individual Federal Open Market Committee member’s view, where each participant at that particular meeting thinks the fed funds rate should be at the end of the year for the current year, the next few years, and the longer run. 
Forecasts and projections are based on current market conditions and are subject to change without notice.
Projections should not be considered a guarantee.

Given these factors, the current policy moment has more of the feel of a “pregnant pause” with respect to rate hikes than an actual ending. In that respect, it appears to be a repeat of the conditions that the Fed—and investors—experienced in 2016. Recall that the Fed first tightened at the end of 2015 and seemed to be on a path towards tightening in 2016, but backed off when investors responded negatively. The FOMC resumed tightening almost a year after their first move, in December 2016. That bit of history should be remembered by investors hoping for an even longer extended period of Fed forbearance.