The Fed has stopped cutting interest rates…for now
After three interest rate cuts in the second half of 2019, the Fed has paused. Economic growth remains lackluster, but serious recession risks seem to have fallen since the summer. The Fed’s next move in 2020, if it makes one, is more likely to be a cut than a hike.
The Federal Reserve (Fed) maintained the federal funds rate target range at 1.50% − 1.75% at its December meeting, the last of 2019. This pause, after three consecutive interest rate cuts, had been clearly telegraphed and widely baked into market pricing.
The statement released after the meeting notably removed a reference to “uncertainties” about the outlook, instead stating that monetary policy is “appropriate to sustain the current expansion.” This language indicates the Fed has less of a bias toward easing than it did a few months ago.
In his press conference, Chair Powell struck a dovish tone by emphasizing that the Fed has no plans to re-raise interest rates as it did after previous mid-cycle adjustments in the 1990s.
What comes next?
The Fed’s forecasts were little changed since September. No members of the committee expect further rate cuts, while a large majority expects to remain on hold in 2020. Beyond next year, more members expect the Fed to eventually increase rates, as inflation rises back to, and perhaps above, its 2% target.
Regarding the outcomes of the policy risks on the Fed’s radar, the committee was largely flying blind at this meeting. The U.K. election, which may shape the final timing and nature of Brexit, is being held the day after the meeting. And the next scheduled round of U.S. tariffs on Chinese imports is still set to take effect on December 15, despite hopes for a last-minute delay or cancellation.
Even so, Brexit and trade are less of a threat to the Fed’s outlook today than they were at the end of the summer. Should they re-escalate, however, the Fed could feel compelled to step back in with more easing.
Evaluating the Fed’s 2019 “mid-cycle adjustment”
We do not expect a U.S. recession in 2020. Assuming we are correct, the Fed has just undertaken its first mid-cycle adjustment—a rate reduction done to prevent a recession rather than to help the economy climb out of one—since the 1990s. In addition, the Fed has restarted a long-dormant balance sheet expansion program to maintain the current level of bank reserves rather than allow it to shrink over time. While monetary policy operates with a considerable lag, the rate cuts already appear to be having some positive effects.
U.S. residential investment—housing construction—contributed to U.S. GDP growth in the third quarter for the first time since 2016. Applications for building permits, a leading indicator for growth, are at their highest in more than 10 years. And the drop in longer-term rates has helped spur a wave of mortgage refinancing, helping households to reinforce their balance sheets.
More broadly, global financial conditions have eased significantly in 2019 as dozens of central banks have eased monetary policy this year. This portends a friendlier environment for businesses and consumers in 2020.
How might rates behave in 2020?
Beyond the near-term event risks, the key question for monetary policy and interest rates in 2020 will be the state of U.S. economic data. U.S. Treasury yields fell throughout most of this year, as data reliably fell short of expectations. As things began to improve starting in September, rates stabilized and even crept up a bit. This steepened the yield curve, as the Fed cut at the short end and longer-term rates rose.
The Nuveen Global Investment Committee does not expect a significant further increase in U.S. rates in 2020, with the 10-year Treasury yield likely to stay in a 1.50% to 2.00% range. A sustained rise above 2% would likely come only in the event of stronger-than-expected global growth.
Despite the December pause, the Fed may have to ease further in 2020. Markets have priced in a little more than one rate cut, which would come only if the Fed’s forecasts prove too optimistic or new risks to the outlook emerge.
Rate hikes are unlikely in 2020. It will take some time for the Fed to once again become convinced that inflation is a serious enough threat to warrant tighter monetary policy, even with the labor market showing signs of tightness. The soonest we see that happening is 2021, in line with the Fed’s dot plot.
Federal Reserve Statement, December 2019.
A basis point is a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%.
The dot plot is a chart that records each Federal Reserve official's forecast for the central bank's key short-term interest rate.
The Federal Open Market Committee (FOMC) holds eight regularly scheduled meetings per year to review economic and financial conditions, determine the appropriate stance of monetary policy and assess the risks to its long-run goals of price stability and sustainable economic growth.
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