The Federal Reserve did more today than increase its benchmark interest rates by a quarter-point, only the third hike in more than 10 years -- it also took an important step forward in a gradual policy transition.
Hoping for what I have labeled earlier a “beautiful normalization” of rates, the central bank is moving beyond strict data-dependency and becoming more comfortable about leading markets rather than following them. In the process of becoming more strategic and less tactical, the Fed will, and should, shine more of the spotlight on others with responsibility for economic policy. This includes U.S. policy-making entities charged with fiscal, trade, labor market and regulatory issues, as well as other systemically important central banks, particularly the European Central Bank and the Bank of Japan.
While we need to wait for the release of the Federal Open Market Committee minutes in a few weeks, the rationale for today’s rate hike and the policy shift is apparent in the statement issued at the end of the two-day meeting. This was reinforced by the comments at Fed Chair Janet Yellen’s press conference that followed the rate increase; and it is one that speaks to both domestic and international factors influencing the economic outlook and the balance of risks.
With the economy continuing to expand at a moderate pace, the Fed highlighted the improvement in business sentiment and welcomed the further strengthening of the labor market. Meanwhile, Fed policy makers took comfort in the rise in inflation toward the central bank’s 2 percent longer-term target. These domestic factors seem to be accompanied by lowered concerns about potential headwinds to the U.S. economy associated with developments abroad.
With that, the Fed’s expected path for future rate hikes -- reflected in what is known as the “dot plot,” which denote individual FOMC members’ projections -- reaffirmed forward guidance for two more hikes this year and three in 2018. The central bankers also delayed detailed consideration of any change in management of its balance sheet, indicating it will continue to hold a large inventory of bonds and asset-backed securities.
All this was largely anticipated by recent market commentary, which had scrambled to adjust to the expectation that the rate increase was increasingly likely at this month’s FOMC meeting. Just over two weeks ago, when facing implied market probabilities of only a 30 percent chance for a March hike, officials worked in a seemingly coordinated fashion to more than triple that expectation; they did so in an impressively quick and orderly fashion.
While not yet reflected in its economic projections and the associated path for future rates, the Fed is monitoring progress in translating President Trump’s trifecta of pro-growth plans (tax reform, deregulation and infrastructure investment) into durable policies. Should the administration and Congress deliver, the Fed would first shift the balance of risks to become more hawkish and then accelerate the timing of its rate increases.
The Fed has been the only game in town for far too long. Fortunately, it now sees a window for an orderly policy normalization. But this isn’t a path that it can navigate well alone. The central bank -- along with both the U.S. economy and the global economy as a whole -- needs other policy making entities to step up and use the tools better suited for the tasks at hand.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco. His books include “The Only Game in Town: Central Banks, Instability and Avoiding the Next Collapse.”
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