Federal Reserve Chair Janet Yellen and the Federal Open Market Committee did not let a little snow delay the start today to their two day meeting, which will conclude tomorrow afternoon with the third rate hike in the gradual ascent of policy normalization that looks near certain to pick up in pace from here.
Here is a synopsis of what we will be looking for Wednesday afternoon:
*** We suspect Chair Yellen will resist affirming a high likelihood of four rate hikes this year in her post-meeting press remarks. The FOMC may hike as many as four times this year, and is likely under current forecasts to tighten three times this year, but it is otherwise too early to signal much on the forward rate path beyond noting the March rate hike should put the markets on alert that every meeting will be truly live from here in an economy at maximum employment and very near mandate-consistent levels of inflation. ***
*** The rate dot projections are highly likely to show another upward migration in all three years of forecasting horizon. While it is more or less a toss-up, on balance there may not be quite enough movement in the 2017 dots to nudge the median from three to four. But if not, the 2018 rate plot will probably capture the hawkish leanings of the FOMC with a median at four hikes. Perhaps even more interestingly, 2019 may show for the first time an FOMC majority projecting an assumed rate path above the estimated longer run neutral rate, indicating the need for an outright tightening. ***
Those Rate Dot Projections
It is, of course, the ever problematic rate dot projections that are near certain to draw all the market attention. Fed officials keep saying, and Chair Yellen will no doubt affirm yet again in her press remarks, that the rate dot projections are not guidance, and are not a commitment. No matter, they are what the market will be scrutinizing more than anything else tomorrow afternoon.
The rate dot projections are always difficult to assess, even internally, because each district staff uses different inputs in their forecasts; a few like in December, penciled in a general fiscal policy boost to aggregate demand without knowing any details about the Trump Administration’s tax, regulatory, and spending policies. More staff may do the same in these quarterly projections.
But even without the Trump effect, the Fed’s confidence in the overall resilience of the economy and the outlook for steady, above trend growth will probably be enough to nudge the rate projections upward again, especially when the economy is already assumed to be at or very near maximum employment and the 2% inflation target.
But overall, this much we can be certain of, that the rate dot plot is very likely to show another upward migration, not only in 2017 but across 2018 and 2019 as well.
Some of the December “one dotters” are likely to move up to two hikes, while one or more of the “three dotters” could indeed move up to four rate hikes this year, perhaps enough to tip the scale of the median from three to four presumed hikes in 2017.
But if not, it is likely to only mean the extra rate hike will show up in the 2018 rate hike projections. And, in turn, we suspect more FOMC members will lift their year-end 2019 rate dot projections above the 3% median longer run neutral rate.
And while the third year in the projections are or should be taken with a huge grain of salt, it would be telling if a majority of the FOMC saw the likely need for an outright tightening in monetary conditions in the fifth year of this unusual cycle in removing monetary accommodation.
Longer Run Neutral
On that front, we would note that Chair Yellen, in her Chicago speech the Friday before last, indicated that the Fed is likely to be at or very near the current or effective equilibrium interest rate by the end of this year or early next year.
But, she said, the Fed still believes it will need to continue with rate increases through 2018 and 2019 because the estimated effective neutral rate will be rising as the economy and overall conditions improve towards its estimated longer run neutral rate of around 3% nominal.
The FOMC, of course, had been reducing that estimate of the longer run neutral rate for several years, culminating by last summer with a neutral rate just below 3%, down from its 4.25% level a few years ago. In December, that downward momentum leveled off with a very slight rise back to a 3% median.
If the FOMC should start lifting estimates of the longer run neutral rate through this year, or even in the March projections tomorrow, that will be a significantly more hawkish takeaway than anything in the speculative debate over whether the 2017 rate median will be three or four hikes.