“Patient” has become the Fed’s favorite word in recent weeks as just about all Fed governors slipped it into their speeches. Today the word made its way into the FOMC statement for the first time. During the Q&A at the press conference, reporters tried to get Fed Chairman Jerome Powell to nail down what “patient” actually means, how long “patient” would last. But they walked out empty-handed.
So what came out today was this:
The Fed will not change its target for the federal funds rate over the near term. It has been between 2.25% to 2.50% since December 19, and that’s where it will stay until the Fed runs out of “patience.”
The QE unwind continues on autopilot as outlined in 2017. The Fed has been discussing over the past three meetings how far to cut its balance sheet, and what the ultimate composition should be. But no decision has been made yet. So stay tuned, it said.
The Fed is pretty gung-ho about the US economy.
In the statement today, it said:
- “The labor market has continued to strengthen.”
- “Economic activity has been rising at a solid rate” (“strong” from the December statement was demoted to “solid”).
- “Household spending has continued to grow strongly.”
- “Growth of business fixed investment has moderated from its rapid pace earlier last year.”
- “On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent.”
Rates are on hold due to “cross-currents”
The slowing economy in China and Europe are on the Fed’s worry list, as are Brexit and the effects of the US government shutdown. Plus, “financial conditions” – yields, spreads, and other indicators that show that it is getting harder to borrow money as risk-taking abates – “tightened considerably late in 2018, and remain less supportive of growth than they were earlier in 2018,” Powell said at the press conference (video) – which is precisely what the Fed had set out to accomplish when it started the rate hike cycle.
These are “cross-currents,” he said. And until they’re sorted out, rates are on hold. The talk about “some further gradual increases” in the December statement disappeared, and instead “patient” became to leitmotif:
In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.
Powel explained why the language changed from “some further gradual increases” to “patient”: Facing this “somewhat contradictory picture” of a “generally strong” US economy and these cross-currents, “common sense risk management suggests patiently awaiting greater clarity.”
And “the case for raising rates has weakened somewhat,” for two reasons, he said:
- The risk of too-high inflation “appears to have diminished” over the past few months.
- And “the risk of financial imbalances appears to have receded, as a number of indicators that showed elevated levels of financial risk appetite last fall have moved closer to historical norms.”
So it’s best to wait and see “how the cross-currents resolve themselves.”
But the QE unwind continues on autopilot.
The FOMC announced in its Implementation Note that there is no change to the process, speed, or mix of the balance sheet normalization process. The Fed would continue shedding Treasury securities at a pace of up to $30 billion a month and mortgage-backed securities at a pace of up to $20 billion a month as they mature.
In a new twist, the FOMC also released an additional statement about its Balance Sheet Normalization. It explained that “after extensive deliberations and thorough review of experience to date,” it would be “appropriate” to inform the public what the FOMC’s plans are “over the longer run” and under what conditions it “could adjust” the current auto-pilot of the asset-shedding process.
A consensus has formed on the Committee. This consensus was explained in greater detail by Powell:
The Committee made the fundamental decision today to continue indefinitely using our current operating procedure for implementing monetary policy. That is, we will continue to use our administered rates to control the policy rate, with an ample supply of reserves so that active management of reserves is not required. This is often called a “floor system” or an “abundant reserves system.”
Under the current set of operating procedures, as outlined in the implementation note released today, this means that the federal funds rate, our active policy tool, is held within its target range by appropriately setting the Federal Reserve’s administered rates of interest on reserves, as well as the offer rate on the overnight reverse repo facility, without managing the supply of reserves actively.
As the minutes of our recent discussions have indicated, the FOMC strongly believes that this approach provides good control of short-term money market rates in a variety of market conditions and effective transmission of those rates to broader financial conditions.
Settling this central question clears the way for the FOMC to address a number of further questions regarding the remaining stages of balance sheet normalization.
The decision to retain our current operating procedure means that, after allowing for currency in circulation, the ultimate size of our balance sheet will be driven principally by financial institutions’ demand for reserves, plus a buffer so that fluctuations in reserve demand do not require us to make frequent sizable market interventions.
The two largest components on the liability side of the Fed’s balance sheet are the two that Powell mentioned:
- Currency in circulation (actual paper-dollars stashed under mattresses, much of it in other countries) has been rising over the years and is currently $1.7 trillion.
- Reserves have plunged from $2.8 trillion at the end of QE in 2014 to currently $1.6 trillion and continue to fall.
Both combined account for $3.3 trillion, but they’re falling due to the sharply falling reserves. Those two combined, plus some buffer, will indicate the minimum size of the balance sheet. But how far should the reserves fall?
“We will be finalizing these plans at coming meetings.”
Well, Powell said, we don’t know yet, and we haven’t decided yet, but we’ll let you know more about our plans over the next few months:
Estimates of the level of reserve demand are quite uncertain, but we know that this demand in the post-crisis environment is far larger than before. Higher reserve holdings are an important part of the stronger liquidity position that financial institutions must now hold.
The implication is that the normalization of the size of the portfolio will be completed sooner, and with a larger balance sheet, than in previous estimates.
In light of these estimates and the substantial progress we have made in reducing reserves, the Committee is now evaluating the appropriate timing for the end of balance sheet runoff. This decision will likely be part of a plan for gradually reaching our ultimate balance sheet goals while minimizing risks to achieving our dual mandate objectives and avoiding unnecessary market disruption. We will be finalizing these plans at coming meetings.
These explanations today from the Fed, given the hullabaloo in the markets about the QE unwind after having ignored it for a year, are “intended to provide some additional clarity regarding the conditions under which we might adjust our plans.”
QE may restart only if things get really ugly:
If the economy spirals down, the Fed will cut rates, but when cutting interest rates to zero is no longer enough, the Fed is willing re-start QE. In its note on balance-sheet normalization, the FOMC said:
The Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.
Powell confirmed in the Q&A that if the economy spirals down and things happen were “zero-lower bound” — with the federal funds rate near 0% — is not enough, QE is back on the table. But only then.
And NIRP is off the table.
Negative-interest-rate policy (NIRP), as practiced in the Europe and in Japan currently, appears to be totally off the table and didn’t deserve a single mention. “The zero lower bound” would be the bottom for the Fed’s target range for the federal funds rate, no matter what. And if that’s not enough, Powell said, “In those cases, the FOMC would be prepared to use its full range of tools, including balance sheet policy.” For forget NIRP.