Fed puts trade and emerging markets aside, remains focused on U.S.
In its September 25-26 policy meeting, the Federal Reserve increased its target interest rate by 25 basis points, 2.00 – 2.25%. Economic projections were revised up slightly, as was the estimate for the neutral interest rate.
Has policy changed?
Aside from the slight – and widely expected – interest rate hike, not much has changed. The central bank continues to move slowly and transparently, avoiding large financial markets surprises.
The Fed removed a line in its statement which said that its policy remains “accommodative.” However, this does not mean that the Fed will remove accommodation from the economy more quickly than before. Instead, the language change is a signal that the Fed considers interest rates to be moving closer to their neutral position, where financial conditions support full employment and stable price growth near 2.0%. Interest rate projections are stable; the Fed expects to raise rates one more time in 2018, likely in December, and three additional times in 2019.
Trade is not yet a worry
When asked about the ongoing impacts of trade negotiations, Powell admitted that board members have heard widespread anecdotal evidence of companies being concerned about these developments. However, the Fed hasn’t seen a major impact of trade on the U.S. economy. They are looking for a loss of business confidence or a sustained negative financial market reaction to indicate that trade is impacting the economy in a meaningful way.
These factors have not yet come to be. However, trade developments into the future could still impact the Fed’s decision-making. Powell highlighted that fair trade generally supports productivity and higher incomes, which would support healthy labor markets and price growth – the Fed’s two mandates. However, if negotiations inadvertently result in widespread tariffs that remain in place over time, the U.S. labor market and prices, as well as international economies, are likely to be impacted.
Emerging markets do not pose a threat
Emerging markets have experienced significant currency depreciation – 10-15% on average – since this spring. Confidence has eroded meaningfully. In some moments, emerging markets have experienced a “guilt by association,” in which relatively healthy economies experience financial market turbulence. In general, however, the Federal Reserve does not see emerging markets posing a major risk to the U.S. economy.
In addition, the Fed does not take international developments directly into account when making its decisions. But international economies are still important for Fed policy. The U.S. may be the world’s largest economy, but international economies provide an increasing proportion of world gross domestic product (GDP) and GDP growth. Similarly, a strong U.S. economy will support demand worldwide, and can impact international currencies and policies. The performance of emerging markets thus matters for the Federal Reserve, even if it focuses purely on the U.S. economy.
A final note on transparency
Chairman Powell spoke about transparency in the press conference. While these statements can sound wonky, they make a difference for markets, business, and policy. For financial markets participants, transparency matters because it improves capital markets expectations, therefore helping to avoid market shocks. For businesses and policymakers – within the U.S. and internationally – transparency helps to make more reasonable decisions and investment plans.
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