Why Esther George supports holding rates

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The Federal Reserve should hold rates and wait for the three 2019 cuts to work their way through the economy before deciding its next move, Federal Reserve Bank of Kansas City President Esther George said Tuesday.

With gross domestic product running near trend, unemployment near 50-year lows, and “inflation low and stable,” she said, “keeping rates on hold for now is appropriate in my view as we assess the economy’s response to last year’s rate cuts and monitor incoming data.”

She opposed last year’s rate cuts, waiting for “clearer evidence that the headwinds from global developments were threatening to derail the ongoing economic expansion,” she said, according to prepared text released by the Fed.

“With an economy growing at or above potential, a strong labor market, and low and stable inflation, policymakers will need time to judge the proper stance of policy,” George said. “We will need to assess whether the 2019 rate cuts prove to be ‘insurance cuts’ that will need to be reversed if headwinds fade” or “a reset to a more neutral policy stance, recognizing that the equilibrium federal funds rate may be lower than previously assumed.”

But if “downside risks and uncertainties persist in a way that keeps investment spending weak and spills over to the consumer, altering the modal outlook,” policy easing would be needed.

The federal funds rate target at a range of 1.5% to 1.75% gives the Fed “limited policy space” to maneuver in a downturn, so “policymakers are likely to find themselves looking deep into the policy toolkit to fight future recessionary shocks.”

The consumer price index gained 0.2% in December, the core rate climbed 0.1%, while year-over-year the headline number rose 2.3% and the core also increased 2.3%, the Labor Department reported Tuesday.

Economists polled by IFR Markets expected CPI to rise 0.3% for the month and 2.3% for the year, and to core to gain 0.2% in the month and 2.3% for the year.

“A sharp rise in gasoline prices was more than offset by a deceleration in shelter prices and declines in prices for used cars and trucks, household furnishings, and airline fares,” said Bank of the West Economics Chief Economist Scott Anderson. “Consumer inflation remains fairly well-contained, implying no change in Fed’s interest rate target in the near-term.”

The report showed broad-based softness, according to Berenberg Capital Markets U.S. Economist Roiana Reid. “Of the 62 primary CPI categories, only 33 experienced price increases; the second fewest since August 2017,” she said. “Moreover, the three-month annualized change in the core CPI decelerated for the fourth consecutive month to 2% from 2.1% and the six-month annualized change decelerated to 2.4% from 2.8%.”

The numbers were “softer than expected across the board, showing no real inflation pressures at all,” according to Edward Moya, senior market analyst, New York at OANDA. “If inflation expectations take a further hit later this quarter, markets will quickly start pricing in a 25-basis point rate cut this year.”

Energy and health care costs are the “upside risks to prices,” said Grant Thornton Associate Economist Yelena Maleyev. “While the Federal Reserve monitors these measures closely, it is the personal consumption expenditures (PCE) Index that it uses for the 2% inflation target; CPI tends to run hotter but even this suggests the Fed will continue to watch from the sidelines.”

“Restrained” inflation further complicates “the outlook for the Fed, which has vowed to remain sidelined at this point,” said Stifel Chief Economist Lindsey Piegza. “However, if price pressures remain subdued, particularly on the PCE, currently at 1.5%, will investors be as complacent with current monetary policy? The Fed’s forecast has assured 2% growth and 2% inflation, suggesting a failure to deliver will eventually result in additional accommodation.”

Small business optimism slipped in December, as the National Federation of Independent Business Small Business Optimism Index fell to 102.7, from 104.7 in November. Only two of the indexes 10 components rose in the month, while seven declined and one was flat.

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Monetary policy Esther George Federal Reserve Federal Reserve Bank of Kansas City FOMC