WASHINGTON (Reuters) – The Federal Reserve's pledge in January to be "patient" for further interest rate hikes, to set a three-year-old process of tightening policy on the road, rowing markets for weeks of turmoil that deleted trillions of dollars off household wealth.
FILE PHOTO: A screenshot shows the headlines that the US Federal Reserve increased interest rates as a trader is working on a post on the floor of the New York Stock Exchange (NYSE) in New York, USA, December 19, 2018. REUTERS / Brendan McDermid / File Photo
But interviews with more than half a dozen decision makers and others near the process suggest that it also marked a more fundamental shift that could define chairman Jerome Powell's tenure as the point where the Fed first followed a world of stubbornly weak inflation. ever slower growth and permanent lower interest rates.
Along with Powell's public comments, Fed minutes and other documents, the image of a central bank is lined up with a period of potentially difficult change as it considers how to do business in the light of the new reality. One question, for example, is about making crisis control policies part of the routine toolkit. Another is about trying to prepare the audience to accept higher inflation from time to time.
For years, politicians have discussed how well traditional central banks fit a world that has been transformed by the global financial crisis a decade ago. But there was a brief October 3 comment from Powell that set off the chain of events that helped settle the case.
"We are far from neutral now, probably," Powell said at a Washington think tank event, referring to an interest rate that is not cool or raises the economy.
Although Powell effectively summarized what the Fed had just concluded on his 25th-26th. September meeting, when the rate increased with stronger than expected growth in the United States, affected his characterization a nerve.
Investors dumped stocks and bonds and feared the Fed was going to drive prices higher than they felt the economy could tolerate.
It was the beginning of weeks of volatility that led the Fed to calibrate its message, with more than one error track along the way.
By doing this, the central bank went beyond fine-tuning its language or adapting to changed circumstances. Interviews with officials as well as analysis of Fed minutes and public statements of the police statements indicate that there is a long-standing consensus that interest rates are likely to never return to crisis levels, and that once established relationships, such as inflation rising when unemployment fell, did not longer the job.
Concern that years of solid economic growth and declining unemployment would inevitably revive inflation or threaten financial stability has been a starting point for Fed debates, but had largely disappeared from the Fed's 18-19 annual meeting, according to a review of Fed meeting minutes and officials' public statements.
GRAPHIC – How Fed Meeting Minutes Reflected Changes in Interest Rates: tmsnrt.rs/2TX9fC0
It was a conclusion that hid in a clear view. After a year when the Trump administration pumped about $ 1.5 trillion of tax deductions and public spending into a full-time employment economy, the Fed will in 2018 miss its 2 percent inflation target again.
"I hate to say we were right," Dallas Federal Reserve president Robert Kaplan told reporters on January 15 in Dallas. "But we have warned for a while that … the structure of the economy has changed dramatically."
Technological innovation, globalization and Fed's focus on the inflation target all kept prices down, and "these forces are powerful and they accelerate," he said.
His arguments echo those made by St. Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari. New Fed Deputy Richard Clarida and Governor Lael Brainard have flagged similar issues.
Later in January, Fed's policy meeting confirmed further interest rate hikes and called "subdued inflation" among the causes, largely adapting the Fed to the prevailing mood among investors so that conditions weakened.
In the beginning, investors seemed to have overreacted to Powell's "far from neutral" remark in early October.
Global markets had absorbed nearly two-year quarterly Fed-rate increases in battle, but returns on US 10-year government bonds spiked one-tenth of a percentage point that day and stocks started a slide that deleted 10 percent of S&P 500 & # 39; s value by the end of November.
If maintained, it was the type of environment, with values falling and the loan conditions tightening, which could damage the Main Street economy and not just the investor class.
The first response from Powell and others at the Fed was that the US economy remained strong and that it was not the central bank's job to coddle Wall Street.
"We see markets very carefully," Powell said in mid-November in Dallas. "But it's one of many, many factors that go into a very big economy."
But investors did not just react to the Fed and the prospect of higher prices. Weakness in business and consumer confidence, which slows global growth and potential disruptions from President Donald Trump's trade war with China, was also introduced.
Over the next few weeks, the Fed tried to build these concerns in its political stance, but it became clear that the situation was more fragile than they had played.
At the beginning of December, part of the bond yield curve is "inverted", with short-term prices rising over long-term in what can be seen as a loss of faith in economic growth.
For months, Fed officials had discussed discussing such developments as the clash and clang of daily trading or treating them as a significant warning. Some, including Bullard, warned against ignoring which markets appeared to be saying, and both he and Kashkari said the Fed should stop raising prices or risk issues.
When the Fed met in December, policemen thought they could square the circle.
Officials continued with a further quarterly hike, as expected at that time, and released updated forecasts showing two more rate hikes for 2019 – one less than in September, but still on the rise.
The Fed hoped that, between a small change in its policy statement and Powell's follow-up conference, things would be quiet, a strategy Fed officials spelled out afterwards in interviews and in minutes of the December meeting.
By replacing the phrase that the Fed "expected" further interest rate increases with one saying it "condemned" them, the central bank tried to show that it was now less committed to tighter policies.
But that nuance was lost in markets, and Powell's assurance on the news conference of a new "patient" Fed was also lost when he described Fed's monthly count of as much as $ 50 billion in assets as on "automatic pilot". "
To investors who undermined the intended message, since the usual decline in Fed's asset holdings effectively served to tighten economic conditions.
S & P 500 fell another 7.5 percent in the days that followed.
Investors felt that the Fed was not "fully appreciated", how market turbulence and "softening global data" put the United States at risk. The Fed's January protocol concluded to see how the December sentence was perceived.
"It was a delicate time, "New York president John Williams told Tuesday. Tweak's December statement" was a pretty subtle message. It is one of the challenges of trying to communicate a very complex and complex situation on just one page. "
Over the next few weeks, the Fed avoided the finesse for a more public recognition that its view of economic reality had changed.
For a January 4 question and answer to the American Economic Association, Powell armed with written notes and one key message that the Fed was "always prepared to change the policy stance and change it substantially" if conditions deteriorated.
After the January meeting, the announcement became official. References to the new "patient" approach and "dumped inflation" cited in the protocols from the December meeting, became part of the Fed's policy statement. A long-standing mention of the need for higher prices was deleted.
The changes did not disagree, even with those who have worried most about inflation and financial risk, timber.
It was a significant moments of unanimity at a central bank that has spent the last decade wondering when, rather than whether inflation or financial risks should occur Over this period, a group of officials – including Powell early in their central bank ranks – have consistently warned that the combination of falling unemployment, cheap money and trillion dollars injected by Fed's crisis policy would inevitably lead to problems.
As Fed's January approaches showed that not all officials have obeyed further interest rate increases, and some noted that a possible turn for the better – a solution to trade tensions for example – could lead to raise interest rates again.
But to veteran Fed observers, the bar is now higher. The January statement, JP Morgan analyst Michael Feroli recently wrote, showed the Fed "subtly but deeply evolving" to a new view of the world where a number of forces have changed the way inflation and interest rates work, and have now changed how the central bank responds.
GRAFISK – Fedets new normal: tmsnrt.rs/2VccqWm
Reporting by Howard Schneider; Additional reporting by Ann Saphir and Jason Lange; Editing by Dan Burns and Tomasz Janowski