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By Charles Tan - March 20, 2019
Content with its patient approach, the Federal Reserve (Fed) left interest rates unchanged today. The Fed also hinted additional rate hikes may be off the table for the rest of 2019, and it announced changes to its balance-sheet reduction effort.
The central bank held the federal funds rate target in a range of 2.25 percent to 2.50 percent, where it's been since December. Today's pause builds on the central bank's recent shift in sentiment. After announcing the December rate hike, the bullish Fed projected it would raise rates twice in 2019. By January, the Fed's tone turned dovish. Slowing global growth, heightened market volatility, and Brexit and trade policy uncertainties gave the Fed pause.
The central bank dropped from its January policy statement explicit references to future rate increases, language that had been a Fed mainstay since 2015. In noting "the case for raising rates has weakened somewhat," Fed Chair Jerome Powell announced he would pursue a patient approach to monetary policy.
In today's policy statement, the Fed noted it continues to expect sustained economic growth, strong labor market conditions and target-level inflation (2.0 percent) as the most likely outcomes. However, in light of slowing global growth, the Fed reiterated its prior commitment to remain patient in determining future changes in short-term interest rates.
The Fed also suggested rates may stay at the current level through the rest of the year. Eleven of the 17 Fed officials projected there would be no need for the Fed to raise rates this year. The remaining six policymakers indicated one or two rate hikes would be necessary. Prior to the Fed's announcement, market forecasts indicated the Fed would hold rates steady through year-end and make one rate cut next year.
We have a slightly different outlook. Specifically, we expect the U.S. economy to stabilize near trend levels of 2.0 percent to 2.5 percent annualized growth. We also expect U.S. inflation to settle near 2.0 percent, with the wages and shelter component showing modest gains. With growth stabilizing, we expect the Fed will remain on hold through at least the first half of 2019. We believe one rate hike in late 2019 or early 2020 may be necessary for the Fed to reach a "neutral" level, where interest rates neither promote nor hinder economic growth.
In addition to taking a more-cautious approach with interest rates, the Fed is easing its "balance sheet normalization" process. In late 2016, the central bank began slowly reducing its balance sheet (its holdings of U.S. government bonds), which had swelled to $4.4 trillion due to the Fed's financial crisis-related bond-buying. The Fed purchased bonds to influence the yield curve's slope and support the financial markets.
Until now, Fed officials noted the normalization process was on autopilot, with $50 billion in bond holdings running off each month. In today's remarks, policymakers indicated the balance-sheet unwinding would slow down and end sooner than expected. Beginning in May, the Fed will slow its monthly redemptions of U.S. Treasury holdings from $30 billion to $15 billion. By the end of September, it will stop redeeming Treasuries. At that point, the Fed will reinvest its $20 billion in monthly redemptions of mortgage-backed bonds into Treasuries.
Powell recently suggested the Fed could once again use its balance sheet as an "active tool" if the economy needed support. Since late 2016, the normalization process has reduced the balance sheet by only 10 percent.
Fed policymakers made modest downward revisions to the economic projections compared with figures released in December. They lowered their growth forecast for 2019, from 2.3 percent to 2.1 percent, and for 2020, from 2.0 percent to 1.9 percent. However, the Fed's long-term growth expectations remained unchanged at 1.9 percent.
The Fed's forecast for 2019 unemployment inched higher, from 3.5 percent to 3.7 percent. Next year, the Fed expects an unemployment rate of 3.8 percent, up slightly from its December projection of 3.6 percent. The Fed's projected unemployment rates remain lower than the Fed's estimates of long-run unemployment, which range from 4.0 percent to 4.6 percent. This outlook suggests the Fed expects the labor market to exceed the central bank's long-standing guidelines for "full employment." If these expectations prove correct, strength in the jobs market may trigger rising wages, which eventually would create inflationary pressures.
In the meantime, the Fed expects core inflation, which excludes food and energy prices, to stabilize at its target level of 2.0 percent in 2019 and 2020. At this level, we believe there is little risk of the economy overheating.
There’s a time for offense, and there’s a time for defense. Global Fixed Income Co-CIO Charles Tan believes it’s time for investors to use caution.
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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.