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TThe US Federal Reserve recently surprised the markets with a significant and unexpected policy change. At its meeting in December 2018, the Federal Open Market Committee (FOMC) raised the Fed's key interest rate to 2.25% -2.5% and announced that it would still increase the benchmark rate three times over. 3% – 3.25%, before stopping. He also said he would continue to clean up his balance sheet of Treasury bonds and mortgage-backed securities indefinitely, up to $ 50 billion (£ 38 billion) a month.
Six weeks later, at the FOMC meeting in late January, the Fed said it was suspending its rate hikes in the foreseeable future and suspend its balance sheet this year.
Several factors motivated the flip-flop of the Fed. First and foremost, policy makers were upset by the marked tightening of financial conditions following the December FOMC meeting, which precipitated a debacle in the global stock markets that began in October 2018. These fears were exacerbated by the appreciation of the US dollar and the effective closure of some credit markets, including high yield and leveraged loans.
Second, in the second half of 2018, core inflation in the United States has steadily risen, unexpectedly reaching the Fed's 2% target and has even begun to fall to 1.8%. Faced with the weakening of inflationary expectations, the Fed was forced to reconsider its rate hike plan, based on the belief that structurally weak unemployment would lead to inflation above 2%.
Third, Donald Trump's trade wars and slower growth in Europe, China, Japan, and emerging markets have raised concerns about US growth prospects, especially after the prolonged closure of the federal government. to which the United States has been confronted.
Fourth, the Fed had to demonstrate independence from political pressure. In December, when he reported further rate hikes, Trump was asking for a break. But since then, the Fed had to fear being blamed in the event of an economic slowdown.
Fifth, Richard Clarida, a reputed economist and market expert, joined the Fed's board of directors as vice president in the fall of 2018, tilting the FOMC's balance in a more dovish direction. Earlier, Fed President Jerome Powell's dovish tendencies had been mastered by a slightly less dovish staff and the third member of the Fed's troika, New York Fed Chairman John Williams, who was in charge of the Fed. expected inflation to progressively exceed the targets set in the labor market. tightened.
The addition of Clarida in a context of stagnant inflation and tightening financial conditions has undoubtedly proved decisive in the Fed's decision to pause the break. But Clarida also seems to have pushed the Fed to a new image in a more subtle way. First, his presence confirms Powell's view that the flattening of the Phillips curve (which baderts an inverse relationship between inflation and unemployment) could be more structural than temporary. Some Fed researchers are not of this opinion and have published an article according to which the uncertainty related to the Phillips curve should not prevent the Fed from normalizing the American monetary policy. But with Clarida's input, the Fed will be more inclined to focus on current inflation trends, rather than the official unemployment rate and its implications according to traditional models.
Moreover, while Fed staff members tend to believe that the potential growth rate of the US economy is very low (around 1.75% -2%), Clarida, like Powell, seems open to the idea that Trump's tax cuts and deregulation policies, combined with the next wave of technological innovation, will lead to slightly stronger, non-inflationary growth.
Finally, Clarida is spearheading a review of the internal strategy to determine whether the Fed should start offsetting sub-target inflation during a recession and a slow recovery by allowing inflation above its target for periods of expansion. And while the review is still in its infancy, the Fed already seems to have embraced the idea that inflation should be allowed to exceed 2% without triggering immediate tightening.
Taken together, these factors suggest that the Fed could remain in pause mode for the remainder of the year 2019. After all, even a slight recent acceleration in wage growth does not appear to have resulted in higher inflation; which implies that the Phillips curve could remain flatter longer. . And, given the de facto news of the Fed a policy aimed at targeting average inflation over the business cycle, a modest and temporary increase in core inflation above 2% would not necessarily be accompanied by policy action.
But if the Fed is expected to remain in a continuation trend for most of 2019, another rate hike towards the end of the year or in 2020 can not be ruled out. The slowing of growth in China appears to be coming to an end and the recovery may begin to strengthen in the coming months, especially if the ongoing Sino-US negotiations lead to a de-escalation of trade tensions. Similarly, an agreement to avoid an economically disastrous Brexit could still be envisaged, and it is possible that the slowdown in the euro zone – especially that of Germany – is temporary.
In addition, global financial conditions are easing as a result of the Fed's and other central banks' new vision, which could translate into stronger growth in the US domestic market. Everything will depend on whether Trump will refrain from launching a separate trade war against the European auto industry, which would again shake the stock markets. However, unless the US federal budget and the debt ceiling are more contentious – not to mention the possibility of an impeachment proceeding against Trump – the United States could be spared serious political and political shocks to the United States. in the coming months.
If US GDP growth remains resilient this year, an acceleration in wage growth and price inflation could follow, and core inflation could even exceed the target in the second half of the year or 2020. And while the Fed seems willing to tolerate a period of temporary inflation above the target, it can not allow this to become the new status quo. If this scenario were to occur later in the year or next year, the Fed could increase its base rate by an additional 25 basis points before settling into an extended break. Whatever the case may be, the new standard will be a US key rate close to 3% or just under 3%.
• Nouriel Roubini, a professor at New York University's Stern School of Business and chief executive officer of Roubini Macro Associates, was senior economist for international affairs at the White House Council of Economic Advisers during the Clinton administration. He has worked for the International Monetary Fund, the US Federal Reserve and the World Bank.
© Project Syndicate
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