Fed Accepting “New Normal”, Takes Rate Increases Off the Table for 2020

Today’s Fed statement and remarks by Fed Chair Powell reflected a continuing change in the relationship between interest rates, economic stimulus, employment and inflation. 2019 resulted in three rate cuts (“mid-cycle adjustments”) which helped spur record stock market highs and low employment. Last week’s Jobs Report was a blockbuster even after accounting for the end of the GM strike. As those increases were implemented, many of the Fed participants indicated expectations of increased inflation this year as employment rose. The theory that full employment will result in inflation has been a bedrock of economic theory for decades. With unemployment at 3.5% and the PCE index at 1.6%, the theory is being tested and failing. By signaling no rate increases for 2020, the central bank is basically daring inflation to return. Many are concerned by polling indicating that public expectations of inflation are at historic lows. Which means that market participants are expecting low inflation and that may create a “self-fulfilling prophecy”. This week’s sad passing of legendary Fed Chair Paul Volcker brought back memories of the Fed’s most significant inflation battle. With inflation running at 12%, Volcker increased the prime rate to 22%, stopping inflation and causing significant pain as unemployment rose. Long memories of the early 1980s move markets to this day as treasuries sell off if inflationary news is in the headlines. The Fed feels that they have reached the “neutral rate” and it’s time to watch the effects. Stay tuned.