The Pause That Refreshes

The Federal Reserve is currently on a quarterly 25 basis point rate hike schedule. Mr. Market has come to view a ‘Pause’ in the steady drumbeat of Fed rate hikes as a more likely scenario. Reasons include a global economic slowdown, trade wars, brexit, European periphery risks, fading fiscal stimulus and a US economy that looks like it has past peak growth. In addition to the standard arguments, I submit two more. The first is Chairman Powell’s statement that extending the recovery is a primary goal. The second is Chairman Powell’s emphasis on bringing risk approach into the monetary policy. Specifically, ‘navigating between the two risks …--moving too fast and needlessly shortening the expansion, versus moving too slowly and risking a destabilizing overheating.’

The idea with the pause that refreshes is that the fed will be more likely to stop rate hikes temporarily with the intention that economic activity continues at a healthy pace, i.e. is refreshed. Put another way, the Powell Fed reaction function is tilted more dovishly than a traditional Fed.  Rather than a steadfast focus on slaying nascent inflation, the focus is on extending the economic cycle. There may be several reasons for this, but I would like to highlight one – broadening the participation of lower income groups in the recovery. My sense is the longer the labor market remains strong the more chance less privileged people have to benefit.  Separately, politicians are floating ideas like universal income to solve this problem. While there are always incentives to extend the economic cycle, politically I think these incentives are heightened now. 

 One problem of course with a pause in the rate hike schedule is the communication challenge. How does the Federal Reserve communicate that a pause in raising rates is not actually the end of the rate hike schedule?  This matters because the Fed does not want the market getting too out of synch with the fed, which could create excess market volatility, think taper tantrum. Bottom line is I believe investors should be thinking more about a scenario where the fed pauses to extent the cycle as opposed to marking the end of the cycle.