Via Financial Times

As the Federal Reserve meets in Washington this week, investors are almost unanimous in betting that the US central bank will keep interest rates unchanged at 1.5-1.75 per cent. Not only that; financial markets think the main policy rate target is most likely to remain unchanged until November next year, according to CME Group’s FedWatch tool.

This is against a backdrop of stellar US jobs numbers, which last month showed unemployment back at 3.5 per cent and wages continuing to rise. All of which poses the question for chairman Jay Powell heading into 2020: if not the lowest unemployment rate since 1969, what might change the Fed’s mind?

“Let’s not be confused here about this discussion of whether the Fed is dovish or not,” says Ethan Harris, head of global economics research for Bank of America Merrill Lynch. “This is the most dovish Fed ever.”

Obituaries of Paul Volcker, who ran the Fed from 1979 to 1987 and who died on Sunday, have focused on his Herculean effort to overcome Seventies-era inflation in the US. In the past year under Mr Powell, in the post since February 2018, the Fed has swung sharply toward the other half of its dual mandate: maximum employment.

Since January the Fed has signalled, then carried out, a quick series of three rate cuts, explaining them as an accommodation to a global slowdown.

But Priya Misra, head of global rates strategy at TD Securities, said Wednesday’s announcements and press conference may indicate the Fed’s long-term thinking on unemployment is changing, and monetary policy that looked accommodative as it began to cut this summer may only now be at neutral.

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The neutral rate is the rate at which central bank policy would neither restrain nor stimulate growth.

If it has fallen, the Fed has no reason to make any changes in 2020, Ms Misra said.

“Maybe you don’t need to take back these cuts,” she said. “Because all you did . . . was unwind the hikes which shouldn’t have happened, because we’ve reassessed [where] neutral [is].”

If the Fed has reassessed, it will show up on Wednesday in the “dot plot” which shows central bank officials’ individual, anonymous estimates of the appropriate long-term policy rate, she said.

Mr Powell himself brought up the neutral rate in his most recent public outing. Speaking to a group of business owners in Providence, Rhode Island, last month, Mr Powell said no one can measure the neutral rate directly, but Fed estimates of this rate had been dropping since 2012, including over the past year.

Line chart of Officials' projections of longer-run policy rate, median (%) showing The Fed's estimate of 'neutral' keeps dropping

Ms Misra said she did not expect the dot plot’s median forecast of 2.5 per cent to change.

“But I wonder [if] that starts to spread out a little bit more,” she said. “Right now there are three officials who are below 2.5. There may be a couple that might get added to that list.”

Mr Powell may be asked on Wednesday about a major review the Fed is conducting of its monetary policy tools, due for completion next year.

As part of that review, Fed officials showed up around the country at “Fed Listens” events, an attempt to talk to community leaders and regular workers, and the chairman has a chance to show what it learnt as it listened — and whether what it heard changed the way it viewed its 2019 rate cuts in hindsight.

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“[Fed officials’] reactions to the Fed Listens events seems to be notable and real,” said Tim Duy, economist at the University of Oregon. “They have clearly become more focused on the benefits of persistently low unemployment rates.”

Over the course of this year, according to Mr Duy, “what we have learnt is that we can push unemployment much lower for longer periods of time without creating inflation than the Federal Reserve believed to be the case maybe a year or certainly two years ago”.

Mr Powell frequently brings up his public listening sessions, and appears to genuinely enjoy them. In Providence he suggested that they had changed his mind as well.

“Recent years’ data paint a hopeful picture of more people in their prime years in the workforce and wages rising for low and middle-income workers,” he said. “But as the people at our Fed Listens events emphasised, this is just a start: there is still plenty of room for building on these gains.”

Erica Groshen of Cornell University’s ILR School credits most of these gains to workers’ increased bargaining power, as businesses become more eager to find new hires. Ms Groshen, who used to be in charge of statistics for the US government’s labour department, also credits a rash of new state and city-level minimum wage laws.

But the Fed’s three interest-rate cuts this year surely helped as well, she said, which gives the central bank a chance to make a case for pushing unemployment down with as much vigour as it has warded off inflation in the past.

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Before this year, “it was a little bit harder to show the ways in which [the Fed] cared about sustaining maximum unemployment. But now this period gives them an opportunity to say look, we take both parts seriously,” Ms Groshen said.

“You could count this year as big success story for the Federal Reserve.”