By Robert Kaplan
In our most recent Federal Open Market Committee (FOMC) meeting, the Federal Reserve decided to leave the federal funds rate unchanged in a range of 1.5-1.75pc. In addition, we made a 5-basis-point upward adjustment to the interest paid on excess reserves (IOER) held by banks on deposit at the Fed. This was a technical adjustment intended to support the setting of the federal funds rate well within the range set by the FOMC.
I supported these decisions as well as the post-meeting communication regarding the path of the Federal Reserve balance sheet. The Fed balance sheet expanded rapidly in the fourth quarter of 2019 as repurchase agreement (repo) operations and Treasury bills purchases were needed to maintain reserve levels.
It is my hope and expectation that, as reserves in the banking system meet or exceed ample levels of at least $1.5tn, the Fed balance sheet will expand only gradually to reflect trend growth in the demand for currency and other Federal Reserve liabilities. I would expect that, over the first half of 2020, the pace of balance sheet expansion will moderate significantly as active repo operations gradually decline and reserve management purchases of Treasury bills slow in the second quarter.
I continue to support a review of our supervisory guidance and regulatory policies in an effort to assess whether we could put Treasury bills and reserves on a more equal footing in terms of bank liquidity management. I also remain open to consideration of other alternatives which could help the Fed run an ample reserves regime with a sensitivity to limiting growth in the size of the Federal Reserve balance sheet.
In this essay, I will briefly discuss my outlook for the US and global economies. In addition, I will explore the impact of these and other developments on the outlook for the energy industry. Lastly, I will describe my views on the current stance of monetary policy in the U.S.
It is the base-case view of Dallas Fed economists that U.S. gross domestic product (GDP) will grow at a rate of approximately 2-2.25pc in 2020. This forecast is based on our expectation that global growth is likely to remain sluggish but will show signs of stabilization due to some calming of trade uncertainties—particularly as a result of the ratification of the United States–Mexico–Canada Agreement, the Phase One agreement with China, and some greater clarity regarding Brexit. In this regard, we also expect US manufacturing to remain sluggish but show some signs of stabilization. Lastly, we expect business fixed investment to firm somewhat from disappointing levels in 2019. These developments, combined with a strong US consumer (which accounts for approximately 70pc of US GDP), should lead to solid growth in 2020.
Of course, this outlook is clouded by the impact of the coronavirus originating in Wuhan, China. This development will likely mean slower growth in China and risks to the downside for global growth. Dallas Fed economists are considering various alternative scenarios for how this virus could impact the US and global GDP growth. However, at this stage, it is still too soon to predict with confidence the ultimate impact of this virus on the US and global economies. Our Dallas Fed team will continue to actively monitor this situation and assess its ongoing implications.
In addition, I am cognizant that the delay in production of the Boeing 737 Max airplane is likely to reduce U.S. GDP growth by as much as 0.4pc (annualized) in the first quarter of 2020. The extent of the full-year effect will ultimately be determined by the timing of a return to production, likely later in the year. Finally, the first half of 2020 will benefit from the return of post-strike production at General Motors.
Against this backdrop, the U.S. consumer continues to be the key underpinning of the U.S. economy. Household debt to GDP has gone from a peak of 98 percent in 2008 to approximately 74pc as of third quarter 2019. In addition to this improvement in household balance sheets, the current rate of unemployment in the US is approximately 3.6pc. Furthermore, the U-6 measure of unemployment—which takes into account the unemployed, plus discouraged workers who have given up looking for work, plus workers who work part time but would prefer to work full time—is currently running at approximately 6.9pc. This reading is near its historic low of 6.7pc reached in December 2019. The labor force participation rate (the percentage of 16 year olds and above either employed or actively looking for work) now stands at 63.4pc, its highest level since June 2013. All this suggests to Dallas Fed economists that the US economy is likely at or past the level of full employment. This further bolsters our near-term confidence in the strength of the US consumer.
Based on our forecast, we would expect headline unemployment to drift down from the current reading of 3.6pc to approximately 3.5pc during 2020. In addition, Dallas Fed economists believe that the personal consumption expenditures (PCE) inflation rate will gradually move toward the Fed’s 2pc target in the medium term. This confidence is bolstered by the fact that the Dallas Fed’s Trimmed Mean PCE measure of inflation, which exes out inflation components with extreme moves to the upside or the downside, is currently running at approximately 2pc on a 12-month basis. Our research indicates that the trimmed mean is a good indicator of future headline PCE inflation trends.
Potential GDP Growth
Expected 2020 growth of 2-2.25pc is in line with the average growth rate of the US economy since 2010. However, this level of growth is sluggish by historical standards. GDP growth is made up of growth in the workforce plus growth in productivity. As I’ve discussed in previous essays, aging demographics and sluggish workforce growth and more modest productivity growth are negatively impacting potential GDP growth in the US.
The Stance of Monetary Policy
It is my view that, based on my base-case outlook for the U.S. economy, the current setting of the federal funds rate at 1.5-1.75pc is roughly appropriate. Consistent with this view, my Summary of Economic Projections (SEP) submission in December 2019 indicated that I expected no movement in the federal funds rate through 2020.
Of course, my views are subject to revision based on how the outlook for the US economy evolves over the course of this year. In that regard, I will be closely monitoring a variety of economic developments and, in particular, continuing to assess how the coronavirus ultimately will impact the US and global economies.
This blog is an extract of the essay by Robert Kaplan, president and chief executive officer, Federal Reserve Bank of Dallas. Please click on the link below to read the full essay and analysis: