The Federal Reserve is set to leave its benchmark interest rate unchanged Wednesday and will likely signal that it expects rates to remain low well into next year despite a robust job market.
Many economists have said they think sluggish growth will even compel the Fed to cut rates at least once in 2020.
A forecast from the Fed for continued low rates would reflect how its assessment of the economy is evolving. Persistently low inflation with very low unemployment has increasingly led many Fed officials to conclude that rates can remain lower for much longer than they thought without spurring higher prices.
After having raised its benchmark short-term rate four times in 2018, the Fed reversed course this year and cut rates three times to a range of just 1.5% to 1.75%. Chairman Jerome Powell has portrayed those cuts as mainly “insurance” against a slowdown resulting from weak global growth and President Donald Trump’s prolonged trade war with China.
Powell and other Fed policymakers have made clear that they are no longer worried that a healthy job market will necessarily fuel excessive inflation. Instead, they would like to see inflation reach their 2% target level after running below it for most of the past seven years.
Even with unemployment at a 50-year low of 3.5%, the Fed’s preferred inflation gauge showed prices rising by just 1.3% in October compared with a year earlier.
Each quarter, the Fed issues its policymakers’ forecasts of the economy and its own rate policies. On Wednesday, when its latest meeting ends, the Fed is expected to project that its benchmark rate will remain unchanged through next year.
Tame inflation and ultra-low unemployment have led Fed officials to rethink their view of the so-called “neutral rate.” This is the point at which the Fed’s key rate is believed to neither accelerate economic growth nor restrain it. The neutral rate typically shouldn’t change very often or very much. But the Fed’s policymakers estimate that the neutral rate is now 2.5%, down from 3% as recently as September 2018.
And Fed Vice Chair Richard Clarida suggested last month that full employment — the lowest rate that the Fed thinks the jobless rate can go before it starts escalating inflation — could be as low as 3.6%. A year ago, the Fed thought it was 4.4%. The central bank’s official forecasts still say full employment is reached when the unemployment rate is at 4.2% — a level it hasn’t reached for nearly two years.
As a result, economists say the Fed may lower its estimates of full employment and the neutral rate to better reflect how low unemployment and inflation have remained. It had long been the belief of economists that consistently low unemployment would inevitably ignite inflation. That hasn’t happened in this economic expansion, which began in 2009.
At his previous news conference in late October, Powell had set a high bar for a rate hike when he said, “We would need to see a really significant move up in inflation that’s persistent before we would consider raising rates.”
Recent economic data has been healthy, providing another reason for the Fed to stay on the sidelines. Hiring in November was the strongest this year, evidence that businesses remain optimistic. Measures of consumer confidence have also stayed high.
Sales of new and existing homes have picked up this year, and auto sales have stayed healthy. That suggests that the Fed’s rate cuts have made it easier for consumers to borrow for big purchases. Mortgage rates have fallen in the past year.
During this week’s meeting, Fed policymakers are also likely addressing their efforts to stabilize short-term lending in money markets. In late September, overnight lending markets seized up, and banks and other financial institutions struggled to find short-term loans. This problem briefly lifted the Fed’s benchmark rate out of its target range.
The Fed started purchasing Treasury bills in October, with an initial monthly buy of $60 billion, to boost banks’ cash reserves and make more money available for short-term lending.
The Fed has also provided additional liquidity through temporary overnight and other short-term loans. Together, the operations have increased the Fed’s balance sheet by nearly $300 billion.
Powell maintains that the purchases are intended to improve the functioning of the financial system and not to ease borrowing rates. That makes it different, he says, from the Fed’s massive bond purchases during the Great Recession and its aftermath, when the central bank sought to drive down long-term borrowing rates to stimulate spending and economic growth.
