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The Fed: Patient Amid Rising Uncertainty

We think the Fed is right to be cautious in the face of rising global economic risks along with uncertainties surrounding politics and policy.

Following this week’s meeting of the Federal Open Market Committee (FOMC), the Fed issued a statement that more forcefully signaled its intention to be cautious in the face of a more uncertain outlook. Policymakers also signaled that they view the current stance of monetary policy as more or less neutral. Therefore, investors should expect the Fed to keep rates steady, for now.

We think the Fed is right to be cautious in the face of rising global economic risks along with uncertainties surrounding politics and policy. Amid only modest inflationary pressures and financial imbalances, a cautious approach is consistent with a balanced risk management strategy that should ultimately lengthen the economic cycle.

Consistent with this, markets have taken note of the Fed’s shift toward caution, and financial conditions have eased again after the significant tightening in late December. The decline in interest rates and recovery in equity prices should help assuage the risk that the U.S. economy slows more meaningfully in 2019.

Balance sheet as a policy tool

Further softening its tone, the Fed also reiterated that during a downturn, it would be prepared to use its full range of tools – including altering the size and composition of its balance sheet (e.g., via substantially more asset purchases or “quantitative easing”) – if a more accommodative monetary policy could not be achieved solely by reducing the fed funds rate.

Fed officials also confirmed that they will maintain the current floor system for setting monetary policy, in which the Fed relies on its administered rates to control a broader range of money market rates. This suggests that the process of shrinking the balance sheet could conclude by the end of 2019.

Importantly, Chairman Powell in his press conference did not clarify whether and how the Fed plans to continue to normalize the composition of the balance sheet when the amount of financial system reserves reaches its steady-state level. Recently, policymakers have discussed various ways of shortening the duration and returning to an all-Treasury portfolio. However, in the end, we suspect the Fed will also seek to maintain a neutral stance on its balance sheet by reinvesting the maturing proceeds pro rata across Treasury auctions.

Implications for the near-term policy path

Looking forward, we believe Fed officials will again revise lower their views on the appropriate path of monetary policy when they release an updated Summary of Economic Projections in March. With the effective fed funds rate now only slightly below the Fed’s range of estimates for neutral monetary policy (2.5%–3.5%) – and, we note, already within PIMCO’s New Neutral range (2%–3%) – along with an outlook for overall financial stability and modest inflation in the U.S., we believe there is little reason to rush into more policy tightening.

Click to read our detailed views on the interest rate outlook and its implications for investors.

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Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the Securities Institutions Act (WplG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

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