The Fed's dovish stance on interest rates has some on Wall Street betting that the central bank will rescue the economy from a possible recession.

One of the most important stories of the past five months, perhaps the key story, has been the Federal Open Market Committee (FOMC) — the 12-member monetary policymaking body of the Federal Reserve. The Fed's interest-rate hike in December 2018, and signals that it would continue to tighten policy in 2019, caused a meltdown in global financial markets. This hawkish tone was quickly followed by a pivot to a more dovish stance, which then rippled around the world. The European Central Bank (ECB) extended its stimulative rate policy to at least the end of 2019, and many central banks in smaller, advanced countries have indicated lower rates.

The central banks of New Zealand and Australia have put rate cuts on their agendas as economic data flow continues to disappoint. The Bank of Canada has turned more dovish. We expect all three central banks to lower interest rates at their next policy meetings. Sweden's Riksbank in April backed off from plans to raise interest rates and postponed an expected hike to the "end of the year or at the beginning of next year." In the United Kingdom, there's not a lot that monetary policy can do while Brexit uncertainty remains high. This has impeded the Bank of England from joining this global swing.

Markets reel over Fed's "transitory" comment

It has been hard to interpret exactly how dovish the Fed is right now. In part, this is because there remain a range of voices within the Fed and, because serious Fed watchers are still struggling to understand Chairman Jerome Powell. As a result, there is more attention on comments from other Fed officials. Vice Chair Richard Clarida is often seen as a voice at the Fed. And the dovish regional Fed presidents are getting more attention because they often seem more interesting than the regional hawks. After all, the hawks don't really say much other than complaining that rates are too low. The Fed is also evaluating the tools and targets of monetary policy. The idea of targeting "average inflation" is under discussion.

The fed funds futures were pricing 25 basis points of easing by December 2019. Traders have been speculating that weaker economic data — such as inflation — or a particularly dovish speech would translate into a rate cut. But at the Fed meeting in May, Powell said the central bank still sees low inflation as the result of "transitory" factors, such as portfolio management services and lower airfares. The word "transitory" was sufficient for markets to reverse course on rate-cut expectations. Treasury yields fell, the U.S. dollar strengthened, and stocks sold off after Powell's comment.

Key components of core inflation

We expect the Fed will hold interest rates steady until something changes. The Fed lowered the interest on excess reserves (IOER) — the interest paid on balances above the level of reserves that depository institutions are required to hold — by five basis points. One can argue that this was a dovish move; it was designed to get more liquidity into a key part of the market where there obviously wasn't enough. But it does not have the same force as a change in the key policy rate target. The most likely economic trajectory would not call for a move either way.

Risks on the downside

The Fed, like other central banks, remains rather constrained. Growth prospects are neither so good nor so bad that a decisive shift is warranted. We also project inflation to hold steady. Risky assets are another constraint; they will decline if the Fed takes a hawkish turn. But if markets keep soaring, we will hear a lot more about risks to financial stability.

If the markets' downward spiral gets bad, it will bring the Fed into play.

We believe the risks of weaker economic performance are greater than the risks of stronger performance. As a result, a rate cut is more likely than a rate hike. But the more likely way to get to a policy change would involve the asset markets. If risky assets price in a stronger global outlook than the actual outcome, they may have to adjust downward. If the markets' downward spiral gets bad, it will bring the Fed into play. Conversely, we remain convinced that any Fed rate hike would have to be quickly reversed because of the effects of higher real rates on risky assets and the clear evidence of a Fed put. The Fed put refers to the notion that the central bank will respond to market turmoil by loosening policy and providing liquidity.

Nominations up in the air

Separately, there are two vacancies on the Fed's seven-member board. Trump's preferred choices for the central bank — Stephen Moore and Herman Cain — took their names out of consideration after opposition from Republicans in the Senate. It is fair to say that Republican lawmakers finally found the moral fiber to object to these absurd nominations. We are spared the spectacle of the Senate that found Nobel-prize winning MIT professor Peter Diamond unsuitable for the Fed, approving Moore or Cain.

Next: Chasing inflation in Japan

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The Fed's pivot on rate hikes has rippled around the world, and many other central banks are adopting a more dovish stance to support growth.