Page 9 - ISQ UK JANUARY 2020

JANUARY 2020

Data-Dependent Diagnosis

The Fed holds that its monetary policy is well positioned to support economic growth,
a strong labour market, and near-2% inflation in 2020. However, the Fed remains
ready to deploy further monetary support should economic data deteriorate further.

US bond yields have been held down by low long-
term interest rates abroad. Some increase in US
bond yields is likely in 2020, reflecting
somewhat higher bond yields outside
the US, but probably not much
given that inflation is expected
to remain relatively low.
Firms have generally
had difficulties in
passing along the
added costs of tariffs
and higher wages. The
Phillips Curve, the trade-off
between the unemployment rate
and inflation, appears to have flattened
significantly, largely due to well-anchored
inflation expectations. Consumer price inflation,
as measured by the deflator for personal
consumption expenditures, has consistently been
below the Fed’s 2% goal in recent years.

FED POLICY WELL POSITIONED
The Fed raised short-term interest rates in 2018 as part of its
policy normalization. In December 2018, officials thought that
monetary policy was still accommodative and most expected
one or two further rate increases in the year ahead. Instead, the The Fed was unwinding its balance sheet at the start of 2019,
Fed lowered the federal funds target rate range three times in but expected to end that in October. In February, the Fed shifted
2019 (to 1.50-1.75%) as it reacted to increased downside risks its balance sheet policy framework from a specified size goal to
from trade policy uncertainty and slower global growth. These one of maintaining an adequate level of reserves in the banking
cuts were viewed largely as insurance against downside risks in system, and anticipated that the balance sheet would
2020. Fed officials believe that monetary policy is currently well eventually expand in line with that goal. The Fed ended the
positioned to support economic growth, a strong labour unwinding of the balance sheet in July, three months early. In
market, and near-2% inflation in 2020. No change in rates is September, a squeeze developed in the repo market. The Fed
anticipated through the first half of the year, but the Fed will stated that this was a technical issue, but the central bank
respond if conditions warrant (that is, if we see deterioration in seemed caught off guard and followed up with efforts to insure
the labour market). The Fed values its independence and its liquidity in the money markets into early 2020.
policy decisions will not be influenced by political pressure.

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