2018 was busy year for Fed, 2019 promises drama

"The markets are obviously nervous about the Fed going too far and there is historical precedent for an overly restrictive Fed slowing the economy too much and hurting financial markets," said Duane McAllister, managing director and senior portfolio manager at R.W. Baird. "The data will drive this Fed and it's likely that if economic data softens in 2019, the pace of monetary policy normalization will also slow."

Also, Fed Chair Jerome Powell will host a press conference after every Fed meeting next year, which he said will help communication by allowing him to explain the Board’s thinking. The market came to believe the Fed would not raise rates at a meeting during this cycle without a press conference. By adding the press conference, the belief is each meeting will be live, although critics say the Fed is unlikely to move at meeting where the quarterly Summary of Economic Projections are released.

“This will enable a more flexible monetary policy environment,” said Doug Duncan, chief economist at Fannie Mae.

Other major topics for central bankers in 2019 are the yield curve and the neutral rate. After remarking in October that rates were far from neutral, Powell later said rates were “just below” the low range of neutral and after the December rate hike, at the bottom of the range of neutral.

The latest SEP pegged the long run neutral rate at 2.75%, currently the fed funds target range is 2.25%-2.5%.

“Chairman Powell is being very predictable and speaking very clearly as we expected,” Duncan said. “We warned at the beginning of the year that there would be no ‘Powell put’ if, as expected, the stock market started to decline amid a tightening in monetary policy. We expect no change on that front unless there is a threat to the stability of financial markets and institutions.”

Balance sheet reduction will continue on autopilot, despite traders' complaints. In October, the maximum monthly runoff increased to $30 billion Treasuries and $20 billion mortgage-backed securities.

“And the effect is cumulative,” noted Bryce Doty, senior VP/ senior portfolio manager at Sit Fixed Income. “So while balance sheet reduction seems like old news, each month has a greater and greater impact due to the permanent nature of the elimination of cash from the financial system."

In February, Jerome Powell replaced Janet Yellen as Fed chair. Powell has presided at meetings that resulted in four 25-basis-point fed funds rate increases, bringing the target from a 1.25%-1.5% range in January to a 2.25%-2.5% range in December.

Richard Clarida won Senate confirmation as Fed vice chair in August and Michelle Bowman was cleared as a Federal Reserve Board governor in November.