Subtle Changes in the Fed Statement Send Significant Signals

Euler Hermes ACI Chief Economist Dan North commented on the Fed’s decision to cut interest rates Wednesday:

As expected, the Federal Open Market Committee (FOMC) lowered the Fed Funds interest rate today by 25 basis points (0.25%) to 2.0%. It was a relatively small cut compared to the previous three meetings where the FOMC cut the rate by 75, 50, and 75 bps respectively, and it suggests a less aggressive tone from the FOMC going forward. While the cut was widely expected, there were also subtle changes in the wording of the accompanying statement which further suggest the Fed is on the verge of ending its cycle of monetary easing.

First, the Fed took a somewhat more hawkish view of inflation than it did in the previous statement from March 18th. While both statements somewhat wistfully hope for “a projected leveling out of energy and other commodity prices,” in today’s statement there were extra, more direct words. There was a specific second reference to inflationary pressures, saying that “…energy and other commodity prices have increased…” This phrase was absent from the March statement and shows a clear acknowledgment that inflationary pressures are rising, and by implication, the FOMC is starting to take a more hawkish stance.

The FOMC also projected an almost exasperated tone when it wrote that “The substantial easing of monetary policy to date… should help…,” words which were also not in the previous statement. These words seem to be explicitly reminding the financial markets that the Fed has already provided them with a substantial “punch bowl” which it is now about to remove. And the words also seem intended to remind the rest of the world that the Fed has already done an awful lot of cutting, but that it takes for time for their actions to work. In both cases the Fed is signaling that the rate cutting is almost over.

The March statement included the rather direct phrase that “…downside risks to growth remain.” No such mention of that risk was made today. The phrase’s absence strongly suggests that the FOMC is now less concerned about economic growth and is by extension becoming more concerned about inflation.

Finally, the vote on the action is revealing. At the FOMC’s previous meeting, Bank Presidents Richard W. Fisher and Charles I. Plosser dissented from the majority vote for a 75bps cut and “preferred less aggressive action”. At today’s meeting, Fisher and Plossner again dissented, but voted for an outright “no change,” suggesting a shift in the FOMC’s assessment away from concern over economic growth towards concern over inflation.

The size of today’s cut, along with changes in the wording of the FOMC’s statement, and a shift in the vote, all suggest that the Fed is becoming more hawkish on inflation and is probably near the end of its cycle of monetary easing.