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In the latest Fed statement, several members of the FOMC -- including Jerome Powell -- formally agreed to remove the term "accommodative." This means policy interest rates are considered high enough now to only weakly support more economic growth. The term was no longer a useful description of current Fed decisions on rates. This appears in line with other public statements made by Fed voting members.
First off, recall this: The term “accommodative” is defined in relation to a “neutral” interest rate, sometimes referred to as “r star” by trained Economists. Estimates of the exact value of this destination “neutral” rate vary over time. In the September FOMC projections, the “neutral” rate Central Tendency resides between 2.8% and 3.0%. Longer run, the range is between 2.5% and 3.5%. The Fed Funds is now set between 2.0% and 2.25% after the September meeting.
Want to know their motivation for dropping the term “accommodative”?
The concept of the “neutral” rate, sometimes referred to as “r-star” by economists, has now become less relevant as a guiding post, given the likelihood of being somewhat in the ballpark of that rate already. Although Powell in his September press conference added that current low rates still spur growth. Rather, Powell indicated a shift in focus to incoming macro-economic and financial data, including a focus on traditional pillars, such as the labor market, the inflation rate, and also to global developments.
This has important implications for the future path of the U.S. economy. The exact path of future rate hikes is not as predictable as it was multiple years ago -- when the only goal was to get back to normal during a prolonged recovery from the deep 2008 financial crisis.
In our view, going forward, market participants need to pay closer attention to the varying regional estimates and forecasts of the FOMC members on inflation, unemployment and GDP. Not just their aggregated “dot plots” showing where they think rate hikes are going.
In fact, New York Fed president John Williams indicated this in a recent speech. The case for forward guidance becomes less compelling in the current environment. That is, a focus on a data dependent policy approach -- rather than the heavy reliance on any estimate of “r star” -- will make rate hike surprises coming out of FOMC meetings more likely.
With that being said, we want to comment on some Fed’s projections and forecasts going forward. In a recent speech, Powell indicated an expectation for a continuation of the trend of unemployment below 4.0% and consumer inflation not rising above 2.0% for the near future. This suggests to us that the Fed will see little pressure to increase rates faster than expected.
In his speech, he also indicated that due to Fed communications policy, differences between consumer and business expectations of inflation pressures are much less pronounced.
Finally, risk-sensitive financial markets are aware. The Fed will raise rates at the slightest hint of inflation. This heightened awareness will curb any mechanisms through which lower unemployment rates (and higher wages) transfer into higher rates of inflation.