So who knew after all the handwringing over the in or out of the “considerable time phrasing” that it would turn out to be almost a footnote to the two days of Federal Open Market Committee policy discussions – it remained in the statement after all, but only in a deliberately eviscerated state that left the phrase straggling on beyond providing any semblance of real policy guidance anymore.
So for us, drawing from today’s package of the FOMC September meeting statement, the Summary of Economic Projections and the blue dot rate plot, the New Exit Principles, and Chair Janet Yellen’s calmly delivered one hour press conference:
*** The single most important takeaway is how hawkish the FOMC has become in shifting the pace in its projected rate tightening. We still think the most likely lift-off in rates is June next year, as more clearly implied now in the dot plot expectations, but that is almost beside the point. It is the more aggressive marking up in the median of the blue dots across all three years of the projections that really leaps out at us, and the markets are right to be re-pricing on that. We do not know how the keep-buying-stock pundits on CNBC are taking today as dovish. The rates and currency markets certainly are not. ***
*** The reason for the faster pace in the rate hikes as indicated in the dots was to prevent inflation from slipping north of its 2% medium term target, with headline unemployment projected to fall to perhaps just 4.9% in 2017. That is well below most Fed estimates of non-inflationary longer run unemployment, and with a 2017 central tendency growth of 2.3%-2.5% that, while falling from its 2016 pace, is still north of the longer run trend growth estimate that was slightly tweaked down again to 2% to 2.3%, the only way to square that circle looks to be higher, faster rate hikes. ***
*** Keeping in mind that the vote on the statement comes after the staff economic presentations and assessing everyone’s assumed policy rate path of blue dot rate plots, the FOMC majority may have felt they almost had to keep the various dovish anchors to the guidance — significant under-utilization, a below normal neutral rate and, of course, the considerable time language — in place to offset a too hawkish market reaction. We suspect the market focus in the coming days and weeks will move from the statement’s language and forward guidance to the rate trajectory of the dots, which have a new lease on life. ***
It is probably a bit early or even goofy to put it in these terms, but beyond the questions over the near term adjustments to the guidance or the timing to the first rate hike, all of today taken together feels to us to be a much more significant new paradigm to the medium to longer term outlook.
Below is our summary of the component parts of the FOMC’s policy presentation today:
On the SEP projections:
The SEP projections for growth were nudged DOWN a bit in 2014 by 0.1% on both ends of the narrow central tendency forecast to 2%-2.2%, and by quite a bit more in 2015 to 2.6%-3% from 3.0%-3.2% — meaning the forecast is slipping steadily below the 3% mark — about the same in 2016 at 2.6%-2.9%, so also slipping below the 3% mark.
But the stunner is a growth slowing quite sharply but still at 2.3% -2.5% in 2017, which is still higher than the longer run trend growth of only 2%-2.3% — which might explain the faster and higher rate tightening in order to keep a lid on inflation.
Unemployment across 2015 and 2016 is more or less the same, a slight improvement, but in 2017 it is projected to hit a 4 handle, albeit barely at 4.9%-5.3% — or well under anyone’s definition of NAIRU.
Inflation is nevertheless projected to stay below 2% until 2016 and right at 1.9%-2% in 2017. We still do not think the inflation target is a ceiling per se, and there may be a willingness to overshoot the target in the years ahead, but it is another to admit it in a forecast. But the only way they could make the inflation stay at 2% with the unemployment dipping below 5% is to raise rates a bit more aggressively.
On the dots:
These were the real show of the day:
– In 2015, the median went up by 25bp to 1.375% from 1.125%;
– In 2016, the median went up by 37.5bp to 2.875% from 2.5%;
– And in 2017, the median was 3.75%;
The 2017 median is right at where they are putting the longer run neutral rate, and seven Committee members put their 2017 dots above the 3.75% to as high as 4% or 3.75% — in other words an outright, old fashioned tightening.
The wide dispersion between the lowest and highest of the rate dots in 2016 and 2017 both suggest there isn’t much consensus yet on the reaction function, not to mention not much sign anymore of the previously assumed extremely gradual rate tightening trajectory.
In her press conference, Chair Yellen furthermore made a point to clarify that the blue rate dots are the midpoint of the targeted range for fed funds, so not quite the effective fed funds rate, though close, but certainly not the IOER rate that many in the market were assuming in pricing fed funds below the previous dots.
On the statement:
The two “natural” dissents as Chair Yellen described the dissents by Philadelphia’s Charles Plosser and Dallas Fed President Richard Fisher immediately leapt out to us before anything else in the statement or even before quickly skimming to see if that damn “considerable time” phrase remained intact.
But on the dissents, they may not mean as much as they might have: Plosser stuck to his time contingency objection, while Fisher aimed his dissent at how far the economy has improved and especially to highlight his concern about financial bubbles. So there were two dissents but for slightly different reasons, somewhat diffusing their impact.
The FOMC confirmed in the statement that QE will indeed be wound down with the last of the tapered purchases completed by the end of October. They did, by the way, retain the option of extending the bond purchases if the recovery should suddenly falter, but assume QE is over and done.
And, of course, they kept the entire guidance paragraph, including the considerable time phrasing in the statement. But Chair Yellen again went out of her way to degrade its “mechanical” six month connotations, and while it did not come out today, we suspect by the time it comes out, it will indeed go out with a whimper not a bang as we wrote they hoped to pull off (SGH 9/11/14, “Fed: Word Play”).
So the Committee did manage to maintain an overall dovish tone to the statement, but again, we think it almost won’t matter much once the implications of the rate projections begin to sink in.
And quickly, on the Policy Normalization Principles and Plans:
What again struck us was the mention of a dissent to the new Principles, but without identifying who or why.
The FOMC confirmed they won’t end the reinvestments until after the rate hikes are started, but offered no real guidance on when or why, and they reaffirmed they won’t be selling the MBS out of the portfolio, and they are still committed — someday — to a treasury only, normal sized balance sheet.
They are still wanting to downplay the role of the overnight reverse repurchase facility in providing a floor to the target range for fed funds, hoping they can pull off the rate tightening by relying primarily on the Interest on Reserve rate, using other facilities like the term reverse repos and the term deposit facility as supplementary support, and to use the ONRR only “as needed” and for only “as long as necessary.”
From what we hear from the short rate market traders on how hard it might be to operate the range without a firm floor, all we can say on that is good luck.