Monetary policy is accommodative and will remain so this year, but with the Federal Reserve’s framework review concluding, some analysts believe the Fed will shift from a 2% symmetric inflation target to an average inflation target.
Such a policy would allow rates to rise above the 2% target to “make up” for past misses to the downside. Since the Fed set the target a decade ago, inflation has missed nearly the entire time.
Fueling the speculation, the sole change the Fed made in its post-meeting statement was it sees inflation “returning to” its 2% target rather than “near” the mark. When asked at the post-meeting press conference, Fed Chair Jerome Powell said the change in language was made to clarify that the Federal Open Market Committee is not comfortable with inflation persistently below its 2% target.
“We expect that after the Fed concludes its framework review, an average inflation target range will replace the current 2% point target,” said Jeffrey Cleveland, chief economist at Paden & Rygel. “As Powell stated in the press conference, an average inflation targeting approach would mark a regime shift from the current policy framework. Average inflation targeting implies tolerance for higher inflation for some period to ‘make up’ for previous shortfalls.”
While policymakers would welcome a rise in inflation, perhaps even over 2% for a while, “We can argue whether a commitment to higher prices will result in a period of sustained higher inflation (case in point: Japan hasn't had much success),” Cleveland said.
“While at first glance, the shift may seem minor, recall that a year ago, the prevailing view at the Fed was higher rates were required as low unemployment posed upside risk to price pressures,” Cleveland added. “The FOMC has completely abandoned that view.”
The decision to keep rates steady and extend repurchase agreements at least through April “conveyed a dovish tilt,” Mickey Levy, Berenberg Capital Markets' chief economist for the U.S. Americas and Asia, and U.S. Economist Roiana Reid, wrote in a note. “We expect the Fed to remain on hold this year, and perceive the bar for hiking rates is much higher than for lowering rates.”
Data
Gross domestic product grew at a 2.1% pace in the fourth quarter and grew 2.3% for 2019, the Commerce Department said Thursday.
GDP rose 2.1% in the third quarter and 2.9% in 2018.
Economists polled by IFR Markets had projected a 2.1% gain for the quarter.
“In the fourth quarter, a downturn in imports, an acceleration in government spending, and a smaller decrease in nonresidential investment were offset by a larger decrease in private inventory investment and a slowdown in” personal consumption expenditures, Commerce said in the release.
The report shows “growth stability,” according to Brian Coulton, Fitch Ratings chief economist. “While business investment continued to fall — the U.S.–China Phase 1 trade deal was not announced until right at the end of the quarter — residential investment saw another sizable expansion, leaving overall capex flat,” he said.
“More importantly the underlying trend in consumer spending growth looks very steady — there have been some big quarter-to-quarter variations driven partly by volatility in durables spending, but the year-on-year growth rate has been unwavering at 2.6% since late 2018. Spending on services — by far the largest chunk of overall consumption — has been very solid.”
Separately, initial jobless claims slipped to 216,000 in the week ended Jan. 25 from an upwardly revised 223,000 a week earlier, first reported as 211,000, the Labor Department said.
Continued claims fell to 1,703 million in the week ended Jan. 18 from 1.747 million the prior week.
Economists expected 215,000 initial claims in the week.
