(Bloomberg Opinion) -- On the surface, this week’s Federal Reserve monetary policy meeting will likely yield little in the way of new information. The Fed will hold its key interest rate constant and make few changes in the accompanying statement explaining the reasons for standing pat. Even so, there are a few potential risks that can’t be ignored by market participants.
One of those risks is that Chair Jerome Powell’s comments on inflation tilt dovish at his press conference following the conclusion of the meeting. In particular, keep an eye out for signs that the Fed’s policy review will culminate with a more aggressive commitment to meeting its 2% inflation objective .
Recall that the Fed has a fairly benign outlook for 2020. It’s basically a “nothing exciting, nothing terrible outlook” that for the moment is supported by the latest data. As Vice Chair Richard Clarida recently reiterated, as long as the economy continues to track along these lines, the Fed will continue to view the current level of monetary of accommodation as appropriate. Powell will reiterate this position in the press conference.
More interesting will be any insights that Powell provides on the ongoing policy review. This is where there is a risk that Powell will tilt dovish relative to the status quo of no policy changes this year. Recall that in previous press conferences, Powell has revealed a desire to tweak the Fed’s policy approach to actually achieve “symmetric 2% inflation” as a means to bolstering the central bank’s credibility on its inflation target and supporting inflation expectations.
A commitment to symmetric outcomes differs from current policy. As it stands, the Fed views the symmetric inflation target as meaning its reaction function is equally concerned with inflation above or below target. In each case, the Fed will seek to guide inflation back to target over the medium term with the same amount of effort, but in neither case will they seek to make up for past errors.
The problem with this approach is that the inflation has persistently fallen short of 2% since the inception of the Fed’s target. Some Fed leaders share Powell’s concern that the persistent undershooting of the target puts downward pressure on inflation expectations, which in turn makes achieving the target more difficult. This issue takes on a greater urgency given the proximity to the effective lower bound on rates. The Fed doesn’t want to go into the next recession with inflation already too low.
In the current environment of low inflation, any change in the Fed’s guidelines that places a higher priority on achieving its inflation target will require a more accommodative policy stance. For example, consider that the Fed may need to guide inflation above target to achieve an average inflation rate of 2% over some chosen time period. To accomplish this would presumably require an easier monetary policy. After all, if the current forecast is predicated on bringing inflation back to 2%, raising inflation above 2% must require more accommodative policy.
More accommodative policy could, in theory, come from further rate cuts or lowering the expected path of rates, essentially pulling out any hikes forecasted for 2021 and beyond. It is interesting to contemplate the possibility of the Fed pursuing more accommodative policy even if it thought the economy was in a “good place” and growth is on the right track.
So while the Fed will maintain its patient policy path at this week’s meeting, watch for signals about changes to the guidelines policy makers are using to plot the way forward. It’s hard to see where any changes would be hawkish relative to the status quo and instead the risk is that policy makes a dovish tilt mid-year as the Fed concludes its policy review.