The Federal Reserve almost got it right today in its decision on interest rates and its explanations thereof. Alas, the two mistakes it made had the effect of badly roiling the stock markets in the immediate aftermath.
In the long run, the Fed’s actions and statements today will have a negligible effect on markets and on the real economy. The markets will probably continue to drop or at best stay in a holding pattern. But the lack of a rally will be due to non-Fed-related reasons, such as trade wars and a possible debt crisis. It won’t be because of further fears of interest rate hikes.
Going into the meeting, I thought the proper move was to raise rates by a quarter point, as expected, and to pronounce the outlook going forward to be entirely neutral and dependent on data. That way, its small rate hike would signal to anti-inflation hawks that it won’t back down to anti-rate-hike hectoring from President Trump. But the move from expected hikes in 2019 down to “neutral” would have reassured those investors who are bizarrely spooked by any rate hike at all.
Instead, the Fed did indeed implement the expected hike — good — but it only moved its forward-looking outlook closer to neutral, rather than entirely neutral. Indeed, the Fed’s official statement never even used the word “neutral” at all. Instead, it said it expected “some” additional “gradual increases” in interest rates in 2019, although perhaps not as many as it expected before.
These tiny verbal signals always have an outsize effect on jittery investors, especially in the short term. Those like President Trump, who hate any rate hikes at all, were not mollified. They began driving “sell” orders.
In the long run, though, benchmark interest rates at 2.5 percent are not high by historical standards. Investors will get accustomed to them, and will eventually take more solace than they did today in appreciating that the Fed’s posture toward further rate hikes is now less aggressive than before.
To the extent that the Fed can keep the economy on an even keel, its new posture should work reasonably well. Alas, those other economic factors, namely trade and debt, which are largely out of the Fed’s control, could have bad ripple effects throughout the economy in 2019.
But where the Fed’s decision and official statement were only a little off, Chairman Jerome Powell’s press conference afterwards was a mess. He rambled too much and, in doing so, he used language that sometimes scared inflation hawks and sometime scared the interest rate doves who oppose them. Both sides heard phrases that made them nervous, and the more Powell talked, the more the markets dropped. Partway through his press conference, the Dow Jones Industrial Average was down only about 50 points for the day; fifteen minutes later, it was down more than 400. It eventually closed down 352.
The Dow Jones isn’t necessarily the economy as a whole, and vice versa. In the long run, the effect of Powell’s remarks will be washed out by events in the real economy. Yet, to the extent, which is not insubstantial, that market jitters themselves affect the real economy, Powell’s contribution to those jitters made it at least marginally more likely that the real economy will suffer.
In plain English, the Fed and its chairman today needed to reassure everybody. Instead, they reassured nobody. They only added to a continuing sense of uncertainty. Their performance today may have been technically sound in terms of pure economics. But Powell left investors still peering into their various “Closets of Anxieties,” still prone to nervously running for cover.
