Both the US Federal Reserve and the European Central Bank (ECB) pushed ahead last month with planned measures to tighten monetary policy even though minutes released last week indicate policymakers were growing more concerned about economic conditions and more cautious about further moves.
The volatility in markets and evidence of slower growth that were worrying investors last month, but seemed to leave the central bankers unmoved, did in fact figure in the discussions. Minutes of the Federal Open Market Committee (FOMC) meeting, held on December 18-19 , show participants holding on to the idea of further gradual increases in benchmark rates, but these concerns “made the appropriate extent and timing of future policy firming less clear than earlier.”
At the meeting of the governing council of the ECB on December 12-13, some participants made the case that risks are now “tilted to the downside.” While policymakers felt risks are still “broadly balanced,” the balance had shifted within that broad framework and “was moving to the downside” due to geopolitical factors, protectionism, market volatility and uncertainty in emerging markets.
The ECB reaffirmed it would not raise rates until the end of summer, but the dovish tone of the minutes has led analysts to expect no action until the fourth quarter at the earliest, and maybe not until 2020.
Likewise, the concerns expressed in the Fed minutes are leading many investors to expect no further hikes in the first half of the year and perhaps during all of 2019. The FOMC participants said that in view of “muted inflation pressures” they “could afford to be patient about further policy timing.”
Fed's New Watchword: Patience
Patient, in fact, became the new watchword in two appearances by Fed Chair Jerome Powell that bracketed the release of the minutes. “With the muted inflation readings that we’ve seen coming in,” he said on January 4 at the American Economic Association meeting in Atlanta, echoing the minutes, “we will be patient as we watch to see how the economy evolves.”
Despite the December dot-plot graph showing policymakers expect two rate increases this year, he said the Fed was prepared to change course “significantly if necessary.” His reassuring remarks helped stocks stage a strong recovery.
Powell repeated this pledge during a conversation Thursday at the Economic Club of Washington, D.C.:
“We have the ability to be patient and watch patiently and carefully as we watch the economy evolve.”
The Fed chair was clearly trying to backtrack on the bullish tone of his December press conference, which alarmed investors and led to a stock market sell-off. Interestingly, it was not the first time Powell misjudged the impact of Fed statements, as newly released transcripts from 2013 meetings revealed.
Each January, the Fed publishes the full transcripts from the FOMC meetings five years ago. Unlike the minutes released three weeks after each meeting, which cloak the participants in anonymity, the transcripts relate remarks verbatim with names attached.
In the April 30-May 1 meeting in 2013, the panel was debating whether to announce it would taper its asset purchases and Powell was one of those urging it to do so. “This is not an unmanageable thing in the context of reasonable economic data,” the future chairman, then a governor, said. “This is not going to be done in a way that provokes a massive reaction of shock from the market.”
When Chair Ben Bernanke followed this advice, he threw markets into a panic that has gone down in history as the “taper tantrum” – a massive sell-off in Treasury bonds that pushed up yields. The sell-off provoked by Powell’s misjudgment at his December press conference took place in the stock market, when the Dow closed down 352 points, having fallen 1.5 percent.
Both in Europe and the US, economic signals are mixed, so it’s hard to predict which way the central banks will go. It seems talk of the Fed actually cutting rates again this year might have been an overreaction to some of the bearish indicators. Likewise, in Europe, the economy is proving more resilient than pessimists were expecting.
The good news is that both the Fed and the ECB are treading more cautiously and not locking themselves into one path or another.