The Federal Reserve left interest rates unchanged at the conclusion of its two-day policy meeting on Wednesday, but strongly hinted that the central bank is ready to cut rates in the coming months if the economy continues to show signs of slowing.
Fed Drops “Further Gradual Increases” Language
In a widely anticipated move, the Fed removed language from its official post-meeting statement that referred to “further gradual increases” in interest rates. This subtle but meaningful change opens the door for the Fed to cut rates as soon as its next meeting in March if economic conditions warrant.
“The case for raising rates has weakened somewhat,” Fed Chairman Jerome Powell said in a news conference after the release of the policy statement.
Economic Headwinds Building
While the Fed characterizes economic growth as “solid,” Powell cited a number of threats that could jeopardize the economic expansion, including slowing global growth, impacts from the trade war, and fading fiscal stimulus from tax cuts and government spending increases.
The Fed’s latest economic projections show GDP growth slowing to 2.3% this year from around 3% in 2018, while the unemployment rate is forecast to tick slightly higher after hitting multi-decade lows.
“We see a situation where the U.S. economy is growing more slowly than last year,” said Powell.At the same time, risks to the outlook appear amplified, with ongoing trade tensions and political turmoil in Washington keeping businesses on edge.”
Markets Betting on Rate Cuts This Year
Financial markets are betting the Fed will need to cut rates before the year is over to protect the economy from a more severe downturn. Traders have currently priced in about a 60% chance of a rate cut by July.
Table summarizing market expectations for Fed rate cuts in 2019. (Source: CME FedWatch tool)
Powell somewhat validated these expectations in his press conference, stating that the case for raising rates has weakened and that the Fed “will be patient as we watch how the economy evolves.”
March Cut Still Up for Debate
While rate cuts could come sooner than later, there is still debate around whether the Fed will pull the trigger as early as its March meeting.
Much will depend on incoming economic data. Key things policymakers will be watching are job growth figures, inflation gauges, consumer spending levels, and fallout from ongoing trade disputes.
If these data points continue their recent downward trajectory, showing broad economic weakness, calls for a March rate cut will intensify. However, the Fed could also adopt a “wait and see” approach, aiming to collect more information before making a major policy shift.
Further Rate Cuts Likely If Conditions Deteriorate
Though uncertain about March, policymakers confirmed they stand ready to enact multiple rate cuts if the economy deteriorates substantially from here.
The updated “dot plot” showing Fed officials’ rate projections point to one or two rate cuts this year, with some members seeing as many as three cuts as plausible. Rates are unlikely to move higher at all in 2019 as risks build.
“I think they are now in a wait-and-see mode,” said economist Diane Swonk of Grant Thornton. “But if we see job growth take a hit, that would change things and accelerate cuts.”
The Fed also confirmed that its balance sheet runoff program will come to a close this year, ending its quantitative tightening measures as precaution given building uncertainty.
Recession Fears Loom
While not an immediate baseline forecast, warnings of an approaching recession continued to grow louder after release of the Fed’s latest policy statement and economic projections.
Former Fed official Narayana Kocherlakota put the odds of a recession starting this year at 50-50, an alarmingly high probability just a decade removed from the Great Recession. “The Fed has very little room to respond with interest rates so low,” he told reporters Wednesday.
Others urged for rapid, decisive action from policymakers to keep the record-long expansion going. “I think the Fed should cut rates in March to get ahead of the curve,” said economist Julia Coronado.
Powell Pledges Patience and Flexibility
For his part, Chairman Powell stated the Fed will remain data-dependent when considering any policy moves.
“We are always prepared to shift the stance of policy and to shift it significantly if necessary” to support growth, Powell told reporters. “We’ll be watching carefully, and patiently, for developments as they unfold,” he concluded.
So while January brought no changes, the Fed is oozing greater caution on the economy, inching toward rate cuts that could placate anxious financial markets. For now the record expansion continues, but its longevity depends more than ever on the course of global trade, government policy, and whether the ever-elusive soft landing the Fed hopes to achieve is in the cards.
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