The takeaway from the Minutes released this afternoon to the two-day Federal Open Market Committee meeting ending February 1 was unmistakably clear: a rate hike is indeed being prepared for as early as the March 14-15 meeting.
*** We have been steadily edging up our odds on a March rate hike since just before Fed Chair Janet Yellen’s Capitol Hill testimonies when she first test drove the “upcoming meetings” language. We now think, barring an unexpectedly southern turn in the March 10 Nonfarm Payroll print, that a March meeting rate hike is more likely than not. ***
*** If a rate move does come as soon as March — and it would be a fairly remarkable shift in the pace of Chair Janet Yellen’s policy normalization strategy — it would be more about maximizing flexibility in the timing to later rate hikes this year rather than making room for a fourth rate hike, which we think unlikely. ***
*** Indeed, purely tactical considerations look to have featured large in the FOMC’s hawkish shift, and in that vein, it is interesting the Minutes noted that forecasts had “changed little” since the December meeting. It is a theme we stressed in our recent reports (see SGH 2/13/17, “Fed: March Positioning” and SGH 2/14/17, “Fed: March Open, May in Play”). ***
Right off, of course, the “fairly soon” phrase obviously stands out in the Minutes — it essentially pushes June out of the picture, brings May closer, and thrusts March into the bulls-eye — but the more important signaling phrase is probably that this fairly soon rate hike would only need to see data “in line with or stronger than their current expectations.”
“In Line” with Current Expectations
The confidence in the economy that has been noted across most of the recent speeches by FOMC members, especially since the end of January meeting underscores the Fed’s belief there is a resilience to the economy’s momentum that will be hard to reverse. It reminds us of that phrase former Chairman Ben Bernanke used to say about looking for an “escape velocity” to be assured about the sustainability of the recovery.
Indeed, there has been a fairly consistent “exceeding of expectations” as departing Atlanta Fed President Dennis Lockhart recently noted, with the data running at or just above the upper ends of staff expectations since the turn of the year, in contrast to the previous years of disappointing starts to the year.
We suspect that makes a surprise softening in the March 10 NFP the last potential brake on raising rates in March.
And that, in turn, seems to have tipped the scales in the burden of proof within the Committee from last year’s extreme caution against moving too quickly to a caution against moving too slowly: in an economy already at or very near maximum employment and a mandate-consistent inflation, it is not so much what it would take in the data to get the Fed to hike fairly soon as it is what it would take for them not to go.
In that vein, Federal Reserve Bank of Boston President Eric Rosengren’s arguments seem to have captured the sentiments of the larger Committee, and his fingerprints look to be all over the January meeting policy discussions.
That is to say, there are strong merits to raising rates “sooner” to limit the downside risks to the recovery in potentially needing to raise rates “more quickly” down the road, especially in the likelihood of more stimulative mix of fiscal and tax policies next year.
In effect, Yellen’s long-argued “sooner and slower” thesis is being taken to task: moving on rates “sooner” in the first half of this year could offer the option of a “slower” pace next year then what may otherwise be necessary to keep near the inflation target.
In that way, a Fed reaction function that is reactive rather than preemptive is better suited for next year when the effects of the “timing, size, and composition” of new fiscal, regulatory, and tax policies will become more apparent.
In the meantime, the safer tact is to move modestly more quickly in removing the degree of policy accommodation rather than risk overshooting either the employment or inflation mandates down the road.
And two other quick points:
The FOMC also acknowledged they need to get into gear on balance sheet policy at their “upcoming meetings.” We think that translates into discussions, papers, and speeches from March through the summer, with September or later being the earliest possible timeframe for a formal revamp to the Exit Principles. The end to reinvestments is not likely before sometime in the first half of next year.
And the FOMC finally got around to revisiting the long-debated revamp of the Summary of Economic Projections and the rate dot projections. But they are nevertheless moving gingerly, opting to keep the changes limited to unveiling with the March meeting SEPs the fan charts that Chair Yellen gave a sneak preview of in her Jackson Hole speech last August.