The Federal Open Market Committee began its year-end two day meeting this morning amid continued stock market gyrations and unrelenting pressure by the White House, now picked up by many investors as well. Against that backdrop, we would make two key points and a few supporting notes to recap our expectations for the FOMC tomorrow:
*** The FOMC will raise the fed funds target range to 2.25%-2.5% and there will be no change in its balance sheet policy. The 2019 rate dot median is more likely than not to drop to two from three hikes in what will otherwise be a modest flattening of a still upward rate trajectory across the forecasting horizon. The “further gradual” phrasing is likely to be dropped from the formal statement and Chairman Jerome Powell will stress instead the data-dependent, risk management policy approach going forward. It would be premature in December to offer a signaling to an end to the rate tightening cycle. ***
*** That said, we do still think a pause of some length in the pace of future rate hikes is likely next year, perhaps becoming evident as soon as the March meeting (SGH 11/16/18, “Fed: A Premium on Policy Flexibility” and “SGH 12/10/18, “Fed: December and When to Pause”). It will have little to do with the President’s pressures or stock market anxieties, but instead driven by a Committee majority view the short run r* will prove to be at the lower end of the “broad range” of neutral estimates and that, data permitting, a persistently inertial inflation will allow for a meeting to meeting assessment of the lagged effects of the accumulative rate hikes going forward. ***
A Rate Hike, Gradual Gone, No Balance Sheet Surprises
** Along with the 25 basis point increase in the fed funds target range, the Interest on Excess Reserves will be lifted by a smaller 20 basis points to 2.40% in another technical adjustment. Speculation the FOMC could opt against the rate hike altogether, or that it would offer a larger IOER spread are both just that, speculation. Rate policy is not driven by market expectations or volatility, Powell may offer, and he may even add that less complacency in market pricing is not necessarily a bad thing if it means the market is taking on more of the price discovery process.
** It is also highly likely the last of the forward guidance language will come out of the statement with the removal of the “further gradual” phrasing. The November FOMC meeting Minutes referenced a “transitional period” in the statement language that could mean a new phrasing rather than a clean break altogether that if adopted, is likely to affirm expectations for a more unpredictable meeting to meeting, risk management approach on rates policy.
** There will be no changes in the Fed’s steady shrinkage in the balance sheet with up to $50 billion in treasury and MBS monthly run-offs, nor will there be any definitive statements on the eventual terminal size of the balance sheet. Chairman Powell may be asked about the so-called “quantitative tightening” of the balance sheet policy, but we suspect he will only offer that the Fed will be seeking to discern the balance sheet impact on financial conditions in the months ahead, and perhaps, if pressed, that the Fed does not believe there is an explicit linkage between its balance sheet run-offs and declines in stock market liquidity or falling equity prices.
** The FOMC statement is likely to remain upbeat on the economic outlook in the first descriptive paragraph, and there is likely to be only modest adjustments in the Summary of Economic Projections. The most noteworthy tweaks may come with some Committee members marking up their estimates of trend growth, but we doubt there will be enough members yet doing so to lift the median from its current 1.8%. The Nairu estimates, however, may see enough movement to bring the median down from its current 4.5% to perhaps 4.4%.
** We expect the 3.0% median for the longer run neutral estimate will probably remain unchanged, though there is likely to be some movement in the fuller ranges back towards the 2.9% of September. And we still think the weight of the Committee is leaning hard towards a short run r* closer to 2.5% than the north of 3% at the upper end of the “broad estimates” of neutral cited by Chairman Powell in his ECONY speech. Powell may be asked on the point, and if so, we think his reply will underscore the Committee majority leaning to a pause of some length next year even if he stops well clear of explicitly ensuring its probability.
The Rate Dot Plot, and Addressing Political Interference
** The 2019 median rate dot plot is drawing an out-sized degree of market attention and, on balance, we think it more likely than not the 2019 median will drop to two from three. The rate path will remain on a cluster-looking upward trajectory, offering no suggestions of an end to the rate tightening cycle. But we do expect a modest flattening of the trajectory through 2020 and 2021 which, as we wrote previously (see SGH 12/10/18, “Fed: December and When to Pause”), would be primarily driven by wider assumptions for a more muted upward pressure on prices from the tight labor market.
** The most important effect of the rate plot will be in shaping the tone of Chairman Powell’s press remarks: if the dots stay at three, for instance, the Chairman will be scrambling to downplay their significance and stressing more dovish rate probabilities; if the median does as we expect drop to two, it will better reflect the Committee’s leanings for a probable pause next year, but to deter an excessively dovish market takeaway, we would expect the Chairman to put a strong accent on the risk management approach that could mean the need for quickened rate hikes at some point down the road.
** We suppose that the risk assessment in the statement and in the Chairman’s press remarks will remain “balanced,” but there is a no small amount of downside risk entering into the Fed’s “monitoring” of financial, economic and international conditions. But the comparison to 2015 and 2016 is misplaced. The market turbulence and Chinese economic uncertainties at the time which led to extreme caution on rates came when the Fed was pressed against the Zero Lower Bound and the US outlook still uncertain, whereas today the economy is running well over its trend estimates and unemployment is nearly a point below most of the longer run estimates.
** We would be curious to see if the “and financial excesses” phrasing makes its way into the December statement. Chairman Powell has dropped some variation of the financial excesses language into just about every one of his speeches in recent months, and it has been picked up by many of his Committee colleagues in their own remarks. While we doubt it shows up in the formal statement itself, we do think there will be a growing reliance by the Fed on the deterrence effects of its Financial Stability Report to address the risks to the economy that has come from financial market excesses rather than goods and services inflation.
** And finally, Powell will no doubt have to address the intrusion of the White House into the Fed’s policy deliberations, as he will certainly be asked for comment in the press conference. He will affirm the independence of the Fed’s policy decisions — from both political pressures as well the market anxieties and volatility. We would note, however, there is some uneasiness starting to build between many district presidents and the politically appointed Board that risks undermining the collegial decision-making process, and which will invariably command more of Chairman Powell’s attention than a high-profile stance defying pubic political pressure from the White House.