AUSTIN, Texas (Reuters) – The Federal Reserve’s decision Wednesday to scrap a promise for further rates hikes and be “patient” on further moves took financial markets and economists by surprise, but the signs were plain to see.
That is the view, at least, of Dallas Fed President Robert Kaplan, who has been warning of downside risks since October, based on widening spreads in the credit markets that signaled tighter financial conditions. Though credit spreads have since narrowed, signaling an ease in financial conditions, slower global growth has amplified his worries since then, he said Friday.
“I am not saying we are never going to raise rates again,” Kaplan told reporters after a talk to The Texas Lyceum in Austin. “I am saying we should not be taking any action now, in my opinion, for certainly the first couple of quarters. And I reserve the right to change my mind.”
Kaplan said that in coming months he will be keeping a weather eye on whether credit spreads “gap out” again, as well as business spending, corporate profits, and financial conditions.
A look at the data so far is not encouraging. Business spending already held down U.S. GDP growth last year, figures from the third-quarter show. Junk bond spreads blew out by more than 2 percentage points in the fourth quarter, though retraced about half of that so far in 2019 and are not extraordinarily wide by historical standards.
Analysts are slashing estimates for 2019 corporate profit growth to single digits or lower, according to Refinitiv’s IBES.
Kaplan’s comments, made just hours after a U.S Labor Department report showed job growth surged in January, underscore the degree to which the Fed’s decisions are being driven by financial conditions rather than macroeconomic data showing strength in the economy.
Kaplan downplayed the jobs report, calling it “noisy” and noting an unexplained rise in people working part-time jobs who would rather be working full-time. For himself, he said, the need to pause on rate hikes has been in the cards for a while.
“I may not have as big a megaphone, but I foreshadowed this,” Kaplan said.
As big a megaphone, he meant, as Fed Chairman Jerome Powell, who in October said the Fed is a “long way” from neutral, suggesting several more interest-rate hikes would be needed to keep the economy from overheating. Powell retreated somewhat from this view in November before again flagging future rate hikes after the Fed’s fourth 2018 rate hike in December.
This week, the Fed left rates unchanged in a well-telegraphed decision. However, the Powell Fed caught markets off guard with extremely dovish messaging both in its post-meeting statement and in the Fed chair’s news conference that followed.
The Fed’s turnaround was “perplexing,” said Roberto Perli, an economist at Cornerstone Macro in one of the more understated reactions. Barclays strategist Michael Gapen said the Fed’s communications were “in tatters.”
“I was concerned coming out of the December meeting that maybe we weren’t in the right place, or we weren’t communicating the appropriate stance. I think to our credit, we rectified that,” Kaplan told reporters, noting that he had said in January that he thought the Fed should pause for a while.
St. Louis Fed President James Bullard, in an earlier interview on CNBC, also said he was pleased with the Fed’s new stance. He also said that while the January job gains were strong, the data is backward looking.
Bullard has been an even longer proponent of stopping rate hikes than Kaplan, and earlier this month said the Fed had come to the “end of the road” on rate hikes.
Though they missed earlier signs of a pause, markets and economists are now fully on board.
Noting the Fed’s new mantra of patience, JP Morgan economist Michael Feroli summed up the implications of the booming jobs market in this way: “It just doesn’t matter.”
Reporting by Ann Saphir with reporting by Howard Schneider, Richard Leong and Dan Burns; editing by Chizu Nomiyama