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Fed’s Powell signals U.S. rates are near neutral...

Dec 4 2018, 04:50 PM (+06) |

Fed’s Powell signals U.S. rates are near neutral – Investors expect rate hikes to slow in 2019

Jerome Powell, the Chairman of the U.S. Federal Reserve, gave his much-anticipated speech in New York at an Economic club last Wednesday. The central bank chief said that he considers that Fed funds rate to be near the neutral interest rate level.

This set the markets off as it signifies an important distinction from the previously hawkish remarks he had made.

"Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy that is, neither speeding up nor slowing down growth," Powell said in his speech.

The remarks from the Fed Chair comes in contrast to the comments he made in early October. Back then, the Fed Chair said that the Fed funds rates were still a long way away from the neutral trades.

This set off a frothy patch in the equity markets. Major stock indexes in the United States reacted bearishly to Powell's comments, and some even fell 10% to mark a correction.

Investors were concerned that the Central Bank would continue to hike rates and at an aggressive pace to meaningfully slow the pace of growth in the U.S. economy.

Since the Fed funds rates are the rates at which central banks lend to each other, they form the basis for most of the consumer debt in the United States. Majorly, the Fed funds rates also impact the mortgage rates. A trend that was seen in recent months as housing markets started to post a decline.

Higher mortgage rates were seen making it more unaffordable for buyers to purchase homes.

The Fed funds rates currently stand at 2.0% - 2.25%. Markets expect another rate hike to come at the December Fed meeting bringing the interest rates to 2.25% - 2.50%.

Questions remain on the number of rate hikes that the Fed will deliver next year. Powell's speech also addressed the current financial conditions in the United States nearly a decade after the financial crisis.

Powell said that the Fed's FOMC does not have a predetermined idea on interest rates. He said that policy decisions would focus on assessing the incoming economic data and financial market conditions.

Following his speech, the markets rallied, and the U.S. Dollar slipped. Investors interpreted Powell's statement to be dovish and a signal that the Fed would slow its pace of rate hikes.

Powell's speech came just a few hours after earlier in the day, the U.S. President Donald Trump once again expressed his displeasure with the Fed's rate hike plans.

“I’m not even a little bit happy with my selection of Jay,” President Trump said in an interview with the Wall Street Journal. Heading into the speech, investors expected Powell to maintain the hawkish tone.

However, it seems that the Fed did capitulate to President Trump’s pressure, given the sudden about turn by Fed Chair Powell.

"While FOMC participants' projections are based on our best assessments of the outlook, there is no preset policy path," he said. "We will be paying very close attention to what incoming economic and financial data are telling us. As always, our decisions on monetary policy will be designed to keep the economy on track in light of the changing outlook for jobs and inflation."

What is the Fed’s neutral rate of interest?

The neutral interest rate is the rate at which the economy is expected to sail smoothly. Usually, when the economy slows, the central bank cuts interest rates to boost the economy.

Likewise, when there are signs of the economy overheating, the Fed hikes interest rates to cool the economy from overheating.

The neutral rate of interest is the rate at which the Central Bank’s interest rates do not influence the economy.

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