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A Fed pivot, born of volatility, error and new economic reality

WASHINGTON (Reuters) – The Federal Reserve's pledge in January to be "patient" for further interest rate hikes, implement a three-year political austerity process, calm markets after weeks of concern that dried out trillions of household wealth. FILE PHOTO: A screen shows the US central bank raised interest rates as a trader working on a post on the New York Stock Exchange in NYSE in the US on December 19, 2018. REUTERS / Brendan McDermid / File Photo But interviews with more than Half a dozen politicians and others near the process suggest that it also marked a more fundamental shift that could define President Jerome Powell's marriage as the point where the Fed first fully embraced 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 examines how to do business against the background of the new reality. One question is, for example, whether the crisis management policy should be part of the routine tool. Another is if you are trying to prepare the public to accept higher inflation from time to time. Policymakers have been debating this year how good a traditional central bank fits a world that is transformed by the global financial crisis a decade ago. But it was a short 3rd comment from Powell that abstained from the chain of events that helped resolve the…

WASHINGTON (Reuters) – The Federal Reserve’s pledge in January to be “patient” for further interest rate hikes, implement a three-year political austerity process, calm markets after weeks of concern that dried out trillions of household wealth.

FILE PHOTO: A screen shows the US central bank raised interest rates as a trader working on a post on the New York Stock Exchange in NYSE in the US on December 19, 2018. REUTERS / Brendan McDermid / File Photo

But interviews with more than Half a dozen politicians and others near the process suggest that it also marked a more fundamental shift that could define President Jerome Powell’s marriage as the point where the Fed first fully embraced 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 examines how to do business against the background of the new reality. One question is, for example, whether the crisis management policy should be part of the routine tool. Another is if you are trying to prepare the public to accept higher inflation from time to time.

Policymakers have been debating this year how good a traditional central bank fits a world that is transformed by the global financial crisis a decade ago. But it was a short 3rd comment from Powell that abstained from the chain of events that helped resolve the issue.

“We’re far from neutral now, probably,” Powell said at a Washington think tank event, referring to an interest rate that is neither cool nor increasing the economy.

Although Powell effectively summarized what the Fed had just finished at its 25-26 meeting on 25-26, when it raised prices by stronger than expected US growth, his characterization touched a nerve.

Investors dumped stocks and bonds, fearing the Fed was aiming to push prices higher than they felt the economy could do.

It was the beginning of the week’s volatility that led the Fed to recalibrate its message with more than one glitch along the way.

In addition, the central bank went beyond fine-tuning its language or adapting to changed conditions. Interviews with officials and analysis of Fed protocols and policy makers’ public statements suggest that a long-term consensus arises that interest rates are likely to never return to pre-crisis levels, and once-established relationships, such as inflation rising when unemployment has fallen, no longer work.

Worrying that years of solid economic growth and falling unemployment would inevitably regain inflation or threaten financial stability has been a pile of Fed debates, but had largely disappeared from the Fed’s 18-19 December meeting, according to a Fed review – meeting minutes and officials’ public statements.

GRAPHICS – How Fed Meeting Minutes Reflected Changes on Interest Rates: tmsnrt.rs/2TX9fC0

It was a conclusion hiding in plain sight. After a year when the Trump administration pumped about 1.5 billion of tax cuts and public spending into a full employment economy, the Fed would in 2018 miss its 2 percent inflation target once again.

“I hate to say we were right,” said Dallas Federal Reserve President Robert Kaplan to journalists on January 15 in Dallas. “But we have long warned that … the structure of the economy has changed dramatically.”

Technological innovation, globalization and Fed’s focus on the inflation target kept all prices down and “these forces are powerful and they accelerate,” he said.

His argument echoed those made by St Louis Fed President James Bullard and Minneapolis Fed President Neel Kashkari. New Fed Vice President Richard Clarida and Governor Lael Brainard have flagged similar issues.

Later in January, the Fed’s political meeting declared some additional interest rate hikes and quoted “subdued inflation” among the reasons, largely adjusting the Fed with the prevailing sentiment among investors who saw the conditions deteriorate.

First, investors appeared to have over-reacted to Powell’s “far from neutral” note in early October.

Global markets had absorbed nearly two years of quarterly Fed rate hikes in battle, but returns on US 10-year government bonds nailed one-tenth of the percent that day, and stocks began to slide out 10 percent of S&P 500’s. value at the end of November.

If it were long-lasting, the type of environment where asset values ​​fell and the loan terms were tightened could damage the Main Street economy and not just the investor class.

The original answer 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 are watching the markets very carefully,” Powell said at a mid-November event in Dallas. “But it is one of many, many factors that go into a very large economy.”

But investors not only reacted to the Fed and the prospects of higher interest rates. Weakening business and consumer confidence, slowing global growth and potential disruptions from President Donald Trump’s trade war with China.

Over the next few weeks, the Fed tried to build these problems in its political stance, but it became clear that the situation was more fragile than they had.

At the beginning of December, part of the bond yield is “inverted” with short-term interest rates over long-term in what can be seen as a loss of faith in economic growth.

For months, Fed officials had discussed whether to discuss such developments as a conflict and timid of daily trading or to treat them as a major warning. Some, including Bullard, warned to ignore which markets seemed to say, and both he and Kashkari said the Fed should stop raising interest rates or risking issues.

When the Fed met in December, politicians believed they could square the circle.

Officials continued with an additional quarterly rate hike, as expected at that time, and released updated forecasts showing another two rate hikes for 2019 – one less than in September but still continuing higher.

LOST NUANCE

The Fed, however, hoped that between a slight change in its political statement and Powell’s follow-up conference, things would be calm, a Fed officials strategy spelled out after the fact of interviews and in minutes of the December meeting.

By replacing the phrase that the Fed “expected” further interest rate hikes with one saying it “convicted” them, the central bank tried to show that it was now less committed to a stricter policy.

But that nuance was lost in the markets, and Powell’s assurance on the new conference of a new “patient” Fed also disappeared when he described Fed’s monthly decline of up to $ 50 billion in assets as on “automatic pilot”. “

To investors who undermined the intended message, because the regular decline in Fed’s asset holdings effectively worked for tight economic conditions.

S & P 500 fell an additional 7.5 percent over the following days.

Investors considered that the Fed “did not fully appreciate” how the market turbulence and “softening of global data” put the United States in jeopardy, the Fed’s January protocol closed when examining how the December statement was perceived.

“It was a sensitive time” “New Williams president John Williams told Reuters on Tuesday. Tweak in the December issue” was a pretty subtle message. Trying to communicate a very complex and complex situation on just one side is one of the challenges. “

Over the next few weeks, the Fed dismissed the subtlety for a more public recognition that its views on economic reality had changed.

For a January 4 issue and response to the American Economic Association, Powell came up with written notes and a core statement that the Fed was “always ready to move the attitude of politics and to move it substantially” if conditions were weakened.

After the January meeting, the announcement became official references to the new “patient” method and “subdued inflation”, words quoted in the protocol From the December meeting, part of Fed’s policy statement became a long-term mention of the need for higher prices has been removed.

The changes made no deviation, even those who worried most about inflation and financial risk had been silenced.

There was one significant moments in unanimity at a central bank that has spent the last decade wondering when, rather than whether inflation or financial risks would recur. During that time, a group of officials – including Powell early in their central bank business – have consistently warned that the combination of falling unemployment, cheap money and trillion dollars injected by Fed’s crisis policy would inevitably cause problems.

FILE PHOTO: Federal Reserve Chairman Jerome Powell holds a press conference after a political meeting in Washington, USA, January 30, 2019. Washington Reuters / Leah Millis – / File Photo

As the Fed’s January meeting minutes showed that Not all officials have been sworn by further interest rate hikes, and some noted that a possible turn for the better – a solution to trade tensions for example – could lead them to raise interest rates again.

But to veteran Fed viewers, the bar is now higher. In the January report, JP Morgan analyst Michael Feroli recently wrote, the Fed showed “subtle but in-depth development” to a new outlook on the world where a variety of forces have changed the way inflation and interest rates work and have now changed how the Central Bank responds.

GRAPHICS – Fed’s new normal: tmsnrt.rs/2VccqWm

Reporting by Howard Schneider; Further reporting by Ann Saphir and Jason Lange; Editing by Dan Burns and Tomasz Janowski

Our Standards: Thomson Reuters Trust Principles.

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