The market has mostly interpreted the Fed’s action in line with our thinking. Despite the lowering of the long-run Fed funds rate, the shifting one of the three hikes from 2019 into 2020, and recognizing that the weaker price impulses are somewhat mysterious, the Fed clearly signaled its bias toward hiking rates one more time this year and three next year.Â
The long-term Fed funds rate has trended lower. In March 2015, it was thought by the Fed’s dot plots to be near 3.75%. A year later it had been cut to 3.25%. It briefly fell to 2.88% in September 2016 before being lift last December to 3%. The cut now to 2.75% has been generally signaled by Yellen (and other officials) suggesting the it may be lower.Â
One of the discrepancies between the Fed and the markets is investors collectively see the long-run rate as considerably lower than the Fed. Looking at the Fed Funds futures strip to give an approximation suggest the market-based view of the long-term rate is closer to 1.75%. The US 10-year breakeven is 1.86%. The implication is that the investors do not think the real Fed funds rate will be positive in this cycle. Â
The biggest surprise about the Fed’s balance sheet signal was the seeming confusion of the media and several times Yellen had to repeat herself. The Fed had, we thought, made it clear, that the balance sheet operations were not going to main tool of monetary policy. The operations would be put on automatic pilot and not disrupted by short run vagaries in the economy.Â
Some seemed critical of this as being rigid, but if it were subject to regular FOMC decisions, the Fed would have been criticized for not aiding market visibility and not being committed to reducing its balance sheet. Some were critical that monetary policy did not address the disparity of wealth and income in the US, but surely this is beyond what monetary policy can do. The Fed’s QE arguably prevented a larger or longer downturn in the economy and this is often forgotten in such discussions. Â
