The change of the US monetary policy trend has been radical since the end of January.
At its January 29/30 meeting, the Fed said it was no longer committing to one or more rate hikes, which was confirmed in March when the “dots” chart was published, and it was going to stop the downsizing of its balance sheet, which it confirmed at its March meeting, indicating a balance sheet target of 17% of GDP in the autumn.
The key elements explaining this radical change lie in the international environment. The Fed sends the signal that because of the uncertain global environment, it wants to remain agile by no longer committing on future movements.It even gives the feeling of wanting to limit its “forward guidance” in order to have more leeway in its monetary policy management.
This role of the international environment may be a source of surprise as the economy is self-centered. Its opening rate is 14% in 2018 against 19% in the Euro zone.
A research by Laurent Ferrara and Charles-Emmanuel Teuf at the Banque de France, quoted by Fed’s Richard Clarida in a recent BdF colloquium, suggests that the international environment is a key factor in the reasoning behind FOMC’s decisions
The authors create an index containing terms related to the global economy, and integrate it into a Taylor formula. The addition of this indicator in the Taylor Formula , that links interest rate to economic activity and inflation, is significant. Greater attention to these external factors is driving the Fed to more accommodating behavior.
We can therefore better understand the change in tone of the US central bank since the beginning of the year. The international environment has deteriorated rapidly (see graph below) and the Fed is taking into account even if its economy remains robust.
See the initial post of Laurent Ferrara and Charles-Emmanuel Teuf on the Banque de France blog
The graph below traces the pace of their index from 1993 to 2017
The following graph shows a Global Economic Policy Uncertainty Index. It suggests and validates the wait-and-see attitude of the Fed in 2016, but emphasizes the opportunity given to it in 2018 to tighten the tone with lower tensions as measured by the index. The year 2019 actually suggests more wait-and-see.