7th March 2019

Legg Mason: Fed outlook: “wait-and-see”

We expect that the Fed will eventually adopt a “wait-and-see” strategy this year, with at most one more rate hike in 2019.

Executive Summary

• The confusion with Fed communications in 2018 reflected its struggle to define a workable strategy for the next phase of the interest rate cycle.
• We expect that the Fed will eventually adopt a “wait-and-see” strategy in 2019. Such a strategy would build on many of the points Fed Chair Powell made in his Jackson Hole speech.
• We expect at most one more rate hike in 2019. If it turns out, as we suspect, that realized inflation continues to undershoot the Fed’s 2% target, then a “wait-and-see” strategy would translate into no more rate hikes this year.
• The Fed’s evolution toward the new strategy has been uneven, and it’s possible that the Fed will once more slip back into its old strategy of removing accommodation before finally and emphatically embracing the “wait-and-see” approach.
   

A Look Back at 2018: Confusing Communications

Communications from Fed officials were rather confusing in 2018. The confusion was not about their near-term intentions. The Fed raised interest rates at every quarterly meeting, and each time the move was almost fully priced into markets well before the event. The confusion was instead about where policy would be headed over the medium term. Fed officials equivocated on how far rates were from the neutral level; they vacillated on whether or not restrictive policy would eventually be warranted; and they obfuscated the substance of their data-dependent approach. Forward interest rate markets magnified these verbal gyrations: two years forward overnight interest rates moved from 2.2% last January to a high of 3.2% in October before moving all the way back to 2.2% at the beginning of January 2019.

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Investments, Investment Commentary, US