With the September Federal Open Markets Committee (FOMC) meeting rapidly approaching, the attitude of some Federal Reserve officials has begun to shift to a slightly more accommodative or certainly less aggressive tone.
Even St. Louis Federal Reserve President James Bullard, who recently applauded the Trump administration’s efforts in spurring growth, appears to be in favor of the Fed taking pause at year-end.
With a lack of meaningful gains in wage growth, a rising risk of yield curve inversion and little worry of an overheating economy as momentum is expected to wane, some Fed officials seem to be shifting from their perpetual “gradual” stance, calling into question the possibility of a fourth-round rate increase at the end of the year.
In less than 11 days, the FOMC is scheduled to meet for the sixth time this year. And, at the Sep. 26 meeting, the Fed is widely expected to raise rates for the third time this year to a range of 2.00-2.25 percent.
Beyond this month’s decision, however, the pathway for rates is becoming increasingly murky as the Fed struggles to find neutral policy with some suggesting current policy is already somewhat restrictive.
In other words, while a September rate hike is seen as a sure thing, further rate action this year and beyond is being called into question with the Fed potentially slowing the pace of adjustments.
Finding neutral
Fed members continue to anticipate a longer-run fed funds rate near 3 percent. However, with the 10-year yield averaging 2.89 percent over the past three months, the Fed’s presumed “neutral” level could potentially distort the curve to the point of inversion.
While not a perfect one-for-one correlation, as the short end of the yield curve follows along with a presumed quarter-point increase at the upcoming FOMC meeting, without an equal rise on the longer end, the differential between short-term and long-term rates could be reduced to next to nothing by month-end.
Such a minimal differential would leave the curve vulnerable to inversion sooner than later. And of course, an inverted curve has historically preceded every economic recession in post-World War II history, a phenomenon which has not been overlooked by the Fed.
Federal Reserve Chairman Jerome Powell is among those who remain skeptical that a curve inversion implies a lurking recession around the corner. Despite being a reliable predictor in the past, Chairman Powell has noted little concern regarding the possibility of an inverted curve.
In previous comments, the Fed chief explained that such an anomaly is more likely a reflection that policy is closer to a neutral level than previous forecasts indicate. Furthermore, given the unprecedented level of monetary policy intervention in the recent past, Powell has warned the yield curve is no longer the predictive measure it once was.
But while the chairman seems undeterred by the risk of an inverted yield curve, other committee members have issued a higher level of concern, warning a curve inversion simply
increases the vulnerability of the economy to recession despite the Trump administration’s pro-growth policies.
Bullard, for example, acknowledged the relative strong growth in the U.S. economy thanks in part to a reduction in corporate taxes and improvement in business sentiment. However, an inverted yield curve, he worries, would exacerbate the likelihood of recession over the coming year(s) regardless of temporary stimulus from fiscal policies.
At this point, the majority of Fed officials
see the economy losing significant momentum over the coming 24 months as the boost from the tax-cut wears off. Potentially maintaining an above trend pace for the remainder of 2018,
growth is expected to slow to 1.75 percent over the longer-run.
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