The Doves won the day at the Federal Reserve today, which noted continued solid economic performance but removed longstanding language that further gradual increases will be warranted, and instead highlighted global developments – both economic and financial – and a moderation in inflation as reasons the Fed will be “patient” in determining the pace of future rate hikes. This is an important change in tone. That said, arguably the most important comments from the Fed today came outside the FOMC statement.

At the same time as the FOMC release, the Fed published a statement regarding balance sheet normalization and the path back towards “normal.” Two items of note came from this second release: 1) the Fed stated that they are prepared to adjust the normalization policy – both in terms of the monthly pace of roll-offs and final balance sheet size – in light of economic developments, and 2) they confirmed that they view balance sheet adjustments (think QE) as a tool they will continue to use in the future in addition to changes to the Fed Funds rate.

Chair Powell himself doubled-down on the dovish tone in his press conference following the release (remember, the Fed Chair will now hold a press conference following each statement, up from once per quarter). In particular, he emphasized that a slowdown in global growth paired with uncertainty surrounding trade, another government shutdown, and Brexit negotiations have put the Fed into wait and see mode. Current rates, he said, are appropriate given the economic and political environment, and he now wants to see a need for further rate increases, while prior meetings suggested the Fed had rates gradually rising on autopilot unless they saw reason to pause.

Short-term jitters can test the most stoic of wills, and Powell’s fortitude is being tested. But fundamentals are what move the economy – and markets – over the long term. And the fundamentals, fueled by entrepreneurship, deregulation, and the tax cuts, continue to point higher.

We continue to believe monetary policy remains far from tight, and that economic activity, by itself, would warrant four hikes this year. However, the Fed wrongly fears an inverted yield curve and is unlikely to raise rates again until the 10-year yield reaches 3.00%. If the economy performs as we expect and if the 10-year yield rises to 3.4%, as well, the Fed should ultimately end up raising rates at least twice, and perhaps three times, in 2019.

Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist