The process of normalization of monetary policy in the United States is approaching a turning point. The Federal Reserve of the United States decided to raise the interest rates by a quarter of a point, to a band that is now between 2.25% and 2.5%. They are already nine increments since the new cycle began just two years ago. But the central bank had to think about it and there is more flexibility in indicating that it will go more calmly, anticipating only two increases in 2019, compared to four this year.
It was one of the most controversial decisions in a long time. It is the fourth increase that is decided this year and the fourth also with Jerome Powell of president. The last time the rates were at 2.25% was in March 2008, after deciding that month a reduction of three quarters of a point. This meeting was especially complicated by the heavy burden of President Donald Trump, who criticized the Fed almost daily, and Wall Street very nervous.
The Republican advised the institution on the eve to "feel" the market before making a decision. "Raising rates," Powell explained, is the best thing to do if the economy does not overheat and sustain expansion. But he does not have a blindfold. The central bank usually understands the tensions in the parquet more as a call to caution to be alert than a red lantern that forces you to change course. It could be, therefore, a factor that will influence the trend throughout 2019.
Optimism in the economy
The central banker continues to declare optimistic about the progress of the economy, although he speaks of "crossed currents" when exposing the situation. They were, therefore, the new projections and the language that was going to use parta justify the decision what will determine the course that will follow. The forecast made by the Fed is a growth of 2.3% in 2019, compared to 3% this year. "We see something moderating," he says. Unemployment will fall by 3.7% and 3.5%. While inflation will be at 1.9%. "It gives us the ability to be patient," he says.
Powell wants to avoid getting caught in a situation where the interest rates are 2%, to have ammunition in the breech. "Some more increase will be necessary," he says, using the word "gradual." The internal survey among the members of the Fed shows that the majority sees possible two increases in 2019. It is a rise less than what was anticipated in September. The long-term interest rate also drops to 2.8%, two tenths less than what was said three months ago. The neutral level would be somewhat closer to 3%.
The goal of the Fed is to bring the rates to a level more normal than that seen during the last decade. The normalization process started in December 2016, with a first increase. In parallel, it is shedding debt assets that accumulated during the crisis. The balance reached 4.5 trillion. It was reduced during the last year by almost half a billion. But it is still far from the trillion before the collapse.
President Donald Trump continues, meanwhile, putting pressure so that the rates are not raised more and the reduction of the balance is suspended. "It's incredible," he repeated on Monday, that "they are thinking about it." Faced with this situation, internal consensus was going to be relevant. All voting members closed ranks in favor of the increase. It is a way to preserve your independence and avoid giving the sensation of rupture.
Powell had no dissident so far since he took over the central bank in February. But that could begin to change soon, because the monetary policy in the US begins to enter a more complex period when it comes to defining what is the appropriate policy for the new economic cycle. Especially if the curve of the rates on ten-year and two-year bonds are reversed.
There are also four voting members who were appointed by Donald Trump. To this is added the rotation among the participants in the committee in which the strategy is decided. Jame Bullard, president of the Federal Reserve of St. Louis, and Charles Evans, of Chicago, will vote in 2019. They are favorable to laxity. Esther George, from Kansas City, and Eric Rosengren, from Boston, are more like hawks.
Monthly press conferences
From now on, the president of the Fed will offer press conferences at the end of each meeting, not just quarterly as he had been doing since the Ben Bernanke stage. It is another way to normalize monetary policy, although it adds a surprise component. Jerome Powell insists that any decision will be adopted according to the evolution of economic data at all times.
The US economy was resistant to the rising price of money, but increases from now on can affect business. It is, in addition, the ballast effect derived from the tariff battle with China. The last Beige Book already indicated in this sense that the effect of the litigation is more widespread and there are companies that begin to pass on the rise in costs to the consumer.
Maintaining the plan, therefore, could have been disastrous. A more rational strategy from now on to see and hope could, however, help neutralize the most pessimistic players in the market. If instead he had chosen to avoid the rise in this meeting due to the weakness of growth, he would have aligned himself with President Trump's catastrophic message.