Faced with growing risks to the economy, the Federal Open Market Committee (FOMC) of the Federal Reserve System opted on June 19 not to change the target range for the federal funds rate. But a large majority of participants lowered their projections for the funds rate in late 2019 and late 2020 by around half a percentage point. The median projection of the longer-run, or neutral, federal funds rate fell from 2.75 to 2.5 percent.
It now appears that the Fed regrets the last two rate hikes in 2018 and is looking for any signs of economic weakness to provide cover for rate cuts. The Fed does not want to acknowledge this change of heart, especially in light of President Donald Trump's public criticism of its policy stance. But it probably would be making the same decision even without Trump.
It all looked so different in 2018. The economy was accelerating from the effect of the large tax cut of December 2017. The Fed was confident that its modest tightening path would not thwart its goal of pushing inflation up, reaching and possibly slightly exceeding its target of 2 percent. Concerns that President Trump would launch a destructive trade war had receded.
Core inflation (based on prices of personal consumption expenditures excluding food and energy) did reach 2 percent in summer 2018, but it unexpectedly dipped back below target early in 2019. More people entered the labor force than most forecasters expected, keeping the labor market from overheating. After modestly undershooting its inflation target for most of the past 10 years, the last thing the FOMC wanted to see was another undershoot.
Meanwhile, trade tensions have heated up again, as a result of Trump's threats to raise tariffs on European, Mexican, and Asian trading partners, especially China. Now the Fed is worried about a hit to business confidence and investment as well as potential weakness in foreign economies that could drag down US exports. If inflation does not return to target or if spending drops noticeably, the Fed is very likely going to cut rates, possibly as soon as late July.
In the press conference after the meeting, Fed Chair Jerome Powell repeatedly stressed the benefits to ordinary households from a strong labor market and affirmed that he did not see any inflationary pressure arising yet on that front. When asked whether the Fed might want to raise its inflation target to 4 percent to be in a better position to confront the zero bound on interest rates and deliver on its employment mandate in future recessions, Powell did not argue that 4 percent would be harmfully high but rather said that the problem is whether achieving such a target would be credible.
Despite the lack of immediate policy action, the changes in the policy projections and Powell's comments at the press conference apparently surprised the markets in a dovish direction, pushing bond yields and the dollar down and stock prices up, albeit only modestly in each case.