February 21, 2019

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Fed Expected to Hold Rates Steady and Emphasize Patience

Fed Expected to Hold Rates Steady and Emphasize Patience
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WASHINGTON — The Federal Reserve has adopted a new theme for the new year: patience.

It is not expected to announce any change in its benchmark interest rate on Wednesday, after its first policymaking meeting of 2019. The Fed’s chairman, Jerome H. Powell, is expected to emphasize that the Fed will take time to evaluate economic conditions before considering any more rate increases.

The recently concluded five-week shutdown of the federal government fogged the Fed’s windshield, reducing the availability of up-to-date economic data. But Fed officials and many outside economists do not expect the shutdown to leave a significant lasting mark on the economy.

Instead, the Fed’s focus is on other signs that economic growth may be slowing, including the weakness of the global economy and the volatility in financial markets. Inflation also remains below the Fed’s 2 percent target. That could be another sign of weakness, and it leaves the Fed with little reason to raise rates again right now.

But Mr. Powell and other Fed officials have repeatedly predicted that the economy will continue to grow this year, and they have insisted that they might continue to raise interest rates later on.

“We have the ability to be patient and watch patiently and carefully as we watch the economy evolve,” Mr. Powell said this month. The voices of other Fed officials in recent weeks have harmonized on the same theme with unusual fidelity, leaving little doubt of the Fed’s intentions.

The Fed has raised its benchmark interest rate in five consecutive quarters. The most recent increase, in December, moved the rate into a range between 2.25 percent and 2.5 percent.

In December, most Fed officials predicted the Fed would raise rates at least two more times in 2019.

Michael Feroli, the chief United States economist at JPMorgan Chase, wrote in a preview of the January meeting that he expected the Fed to make clear that any rate increases in 2019 would depend on the strength of the economy. “At the same time,” he wrote, “we think they will try to avoid giving the impression that pause equals stop, or that the economic outlook has materially downshifted.”

A major focus of the January meeting is likely to be on the mechanics of monetary policy.

After the financial crisis, the Fed changed the way it moves interest rates, and it must decide whether to keep the new system in place or return to the precrisis system.

Investors are watching that decision closely because it will determine how much money the Fed keeps in the bond market.

Under either system, the Fed plans to reduce its holdings of Treasuries and mortgage bonds, which it acquired as part of its campaign to stimulate economic growth after the 2008 crisis. It is reducing its more than $4 trillion portfolio at a slow and steady pace, shaving about $45 billion every month.

Under the new system, however, the Fed would stop selling bonds sooner and retain a larger portfolio.

The decision has limited implications for the general public. Some Fed officials and outside experts think that the new approach has improved the Fed’s ability to influence economic conditions, but the practical difference is generally regarded as modest.

Some investors also argue that the Fed should reduce the pace of its retreat because the diminution of its holdings is contributing to volatility in financial markets. The Fed, and a number of outside analysts, have dismissed these concerns as baseless. Seeking to soothe markets, however, Fed officials have also said they are willing to slow the pace if they see convincing evidence of problems.

Before the financial crisis, the Fed influenced economic conditions by adjusting the quantity of reserves in the banking system. Banks are required to hold reserves in proportion to deposits, so constraining the supply forced banks to compete for the available reserves by paying higher interest rates. That, in turn, caused banks to raise interest rates on loans.

During the crisis, the Fed pumped enough reserves into the banking system to cut short-term interest rates nearly to zero. Then it continued to pump reserves into the system, purchasing Treasuries and mortgage bonds to bring down long-term rates.

The result is a system still awash in reserves.

Since 2015, the Fed has gradually raised short-term rates by simulating a scarcity of reserves: It pays banks to leave the extra money untouched.

A number of Fed officials, including Mr. Powell, have indicated they prefer the new mechanics, suggesting the Fed is likely to maintain excess reserves in the banking system. To do so, some analysts project it would need to stop reducing the size of its bond holdings as soon as the second half of 2019.

That is creating a communications problem for the central bank. Investors have tended to treat decisions about its bond holdings as evidence about its economic outlook, and about its plans for short-term rates.

Mr. Powell has tried to convince investors that decisions about the balance sheet are technical in nature, and were unrelated to the Fed’s plans for interest rates. Tim Duy, an economist at the University of Oregon who follows the Fed closely, predicted Mr. Powell would renew that attempt on Wednesday.

“Good luck with that though,” Mr. Duy said. “I suspect that any indication that the Fed is winding down quantitative easing will be read as a dovish signal,” meaning that markets would interpret the decision as suggesting the Fed is less likely to raise rates.



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