US Interest Rate Policy: The Fed strikes back

As the global economic headwinds intensify,  Federal Reserve officials have made it plain they while they are searching for the neutral level of US interest rates they are also watching slowing growth overseas. 

Fed Vice Chairman Richard Clarida noted that, "...I think being at neutral would make sense', in a CNBC interview on Friday. “The global economy is something" the Fed should monitor, because there "is some evidence that it's slowing." 

His remarks along with those of Chairman Powell on Wednesday gave markets notice that after more than two years of steady rate increases the central bank may pause to consider the economic landscape.   "If you look down the road you see challenges ahead. We have to be thinking about how much further to raise rates and the pace at which we will raise rates," said the Fed Chairman.

The comments sent the dollar reeling, losing 1.2% against the euro from its Tuesday close at 1.1285 to its Friday finish at 1.1416 and 0.8% versus the yen,  from 113.77 to 112.80.

Treasury yields skidded with the return on the 10-Year Treasury dropping 8 basis points from Tuesday to Friday, 3.1450% to 3.0647%.  For the credit markets the importance is not so much the actual yield which has been back and forth over the territory between 3.0% and 3.3% since the beginning of October but the turn away from the territory above 3.3%. 

It has long been a market assumption that the Fed's goal of normalization aimed to return interest rates into at least the lower reaches of their historical range before the Fed quantitative easing policies drove them to all-time lows in 2012 and 2016.  For the benchmark 10-Year that is between 3% and 4% for the immediate post-recession years and 4% to 5.5% for the eight years before the financial crisis. 

If the Federal Reserve governors are becoming cautious here at 2.25% with the 10-Year yield about 1.5% below the mid-point of the decade before 2008, the four 0.25% increases listed in the September projection materials may have to be revised. New materials will be issued after the December 18th-19th FOMC meeting.

There are several items in the global economic picture to give the governors pause. A short list would include, Brexit, clean or negotiated and its effect on the UK and EU economies, the Italian budget dispute, economic slowdowns in Germany and the European Union,  weakening growth in China and finally the effect of the Democratic takeover in the House and falling equity prices on US economic activity. One or two alone could seriously curtail global growth. Caution is merited.