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Seeking middle ground, Fed raised rates, will be careful with increases next year

Traders at the New York Stock Exchange listened as Federal Reserve Chair Jerome Powell spoke.
Traders at the New York Stock Exchange listened as Federal Reserve Chair Jerome Powell spoke.(Mark Lennihan/Associated Press)

Walking a fine line between being overly optimistic and too pessimistic, the Federal Reserve bumped up its benchmark interest rate on Wednesday and said the US economy remained strong, but it warned of possible headwinds next year and signaled it would tighten credit twice in 2019 rather than three times as it previously forecast.

Fed chairman Jerome Powell, facing unprecedented public pressure from President Trump to keep short-term rates unchanged, went ahead with a widely anticipated quarter-point increase, the fourth this year and the ninth since 2015, when policy makers began a campaign to bring the cost of borrowing to more normal levels after they sat at historical lows in the wake of the 2008-2009 financial crisis.

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The move showed that the Fed sees the economy growing quickly enough to require a tap on the monetary brakes to keep it from overheating. It will mean higher costs for business loans, balances on credit cards, car loans, and home equity loans — all of which are driven by short-term Fed rates. Mortgage costs, which are pegged to longer-term rates, may not move higher, but CD rates will.

The Fed’s decision also demonstrated Powell’s determination to pursue an independent course based on economic analysis rather than bow to critics like the president — and many investors — who argued that the recent stock market sell-off and mixed signals about the durability of the nation’s long expansion warranted a pause in any more hikes.

“In our view, these developments have not fundamentally altered the outlook,” Powell said at a news conference after the policy-setting Federal Open Market Committee wrapped up a two-day meeting in Washington.

At the same time, Powell tried to make clear the Fed would not blindly pursue its effort to normalize borrowing costs at the risk of inadvertently triggering a recession. Not only did the Fed drop the number of expected rate increases in 2019, it published forecasts on Wednesday suggesting that only one additional step higher would be necessary to bring rates to a “neutral” level where they neither stoked growth or hindered it.

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“There’s significant uncertainty about the — both the path and the ultimate destination of any further rate increases,” Powell said, adding that low inflation “gives the committee the ability to be patient in moving forward.”

In other words, he tried to tell the world, the Fed would be flexible as it tries to keep the economy humming without risking a surge in inflation.

But like anyone seeking a compromise, Powell ended up making few people happy.

“Had the Fed been more dovish, it would have been confirmation bias for investors worried about growth next year,” said Megan E. Greene, chief economist at Manulife Asset Management in Boston, referring to concerns that a softer approach to rates signaled that the Fed saw trouble brewing next year. “If it had been more hawkish, investors would have worried . . . the Fed would kill off yet another recovery.”

Investors registered their displeasure with the Fed’s tightrope-walking by sending stocks sharply lower. The Dow Jones industrial average swung from a gain of 380 points just before the 2 p.m. Fed statement was issued to a loss at the close of nearly 352 points, or 1.49 percent. The Standard & Poor’s 500 index shed 1.54 percent, while the Nasdaq dropped 2.17 percent.

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All three indexes are in the red for the year, with the S&P 500 down the most with a 6.23 percent loss. From its peak in November, the gauge has tumbled 14.5 percent.

The stock market’s fall from record highs is worrisome to anyone saving for college or retirement, with many remembering the painful losses their 401(k) balances sustained during the financial crisis.

There was a lot of information released by the Fed for investors to digest.

“Economic activity has been rising at a strong rate,” the central bank said in a statement issued after the meeting. “Job gains have been strong, on average, in recent months, and the unemployment rate has remained low.” Inflation is running at about 2 percent, its target, and there are few signs of its picking up.

With that in mind, the Federal Open Market Committee, a group that includes Fed governors and a rotating cast of regional Federal Reserve Bank presidents, voted unanimously to increase the target for the federal funds by a quarter-point to a range of 2.25 to 2.5 percent. The fed funds rate, which the central bank affects by buying and selling Treasuries and other securities, influences short-term rates on consumer and business loans.

The consensus of the committee was that the fed funds rate would have to rise twice next year, which is down from a forecast of three expected increases previously. The change reflects the Fed’s view that economic downturns in China and Europe, plus continued big swings in financial markets, could cut into growth. The Fed forecast one rate increase in 2020.

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Committee members also adjusted the estimate for the neutral level for the fed funds rate to 2.75 percent from 3 percent. Since the Fed typically moves in increments of 0.25 percentage points, that means the neutral position could be reached with a single additional bump.

That move sent the yield on 10-year Treasury notes lower to 2.756 percent from a recent high of 3.238 percent in November. The decline reflects the scaling back of both the number of increases the Fed expects and the neutral rate it is seeking. This longer-term debt drives mortgage rates, so they may actually come down.

The Fed has come under sustained criticism from President Trump, who has not followed the practice of his many predecessors of not commenting publicly on the central bank’s actions. He said the Fed was wrong when it raised rates earlier this year, and on Tuesday he tweeted: “Feel the market, don’t just go by meaningless numbers.”

The president didn’t immediately comment on Wednesday’s Fed action. But Powell said the Fed would be driven by the economic data it sees, and insisted it wouldn’t be influenced by politics.

“Political considerations have played no role whatsoever in our discussions or decisions,” he said. “Nothing will deter us from doing what we think is the right thing to do.”

Larry Edelman can be reached at larry.edelman@globe.com. Follow him on Twitter @GlobeNewsEd. Sign up here for the Globe’s morning business newsletter, Talking Point AM.