Why the Fed Solidified Its Policy U-Turn

The Federal Reserve on Wednesday solidified a remarkable dovish policy U-turn that cannot be properly justified by the outlook for the U.S. economy. Instead, the central bank’s decision to scale back its projected interest rate hikes this year could also reflect a combination of concerns about the international environment and financial market volatility, along with a desire to buy some insurance for the economy and minimize criticism from the White House. The exact mix will matter a great deal down the road, given that the Fed opted this week to sacrifice policy flexibility for 2019 in favor of giving bullish investors exactly what they desired.

Three months ago, the Fed was still signaling several rate hikes this year. At the conclusion of its two-day policy meeting Wednesday, it slashed that forecast to none and announced what many would have regarded as an unusually early end to the removal of exceptional liquidity. Moreover, the end of balance-sheet reduction in September will include a glide path with a declining rate of runoff. This also was a stunning change from the central bank’s policy guidance as late as last December when it suggested an “autopilot approach” involving no change to the pace of balance-sheet reduction and a resting point well below where the balance sheet will be in September.