With a rate hike all but certain at next week’s Federal Open Market Committee meeting, the policy debate is already shifting to the likely messaging for the rate path beyond March.
*** Even if they are all on board with the FOMC majority consensus, not all the Committee voting members are entirely comfortable with a March rate hike. For that reason, we suspect there will be a trade-off for the sake of a firm consensus on the rate decision that the messaging will push back against an assumption of four quarterly rate moves this year or even that a June move is a high probability. It is not that the rate path is pre-set, it is just that it would be too early to signal what would be a pretty aggressive quickening in pace from one to four hikes in a single year. ***
*** When Chair Janet Yellen said in Chicago on Friday that the pace of rate hikes is likely to pick up, she meant going from the glacial, risk-averse, once a year hikes of 2015 and 2016 back to the original sense of a gradual scaling back of accommodation: there could be as little as two hikes if economic momentum slows or yes, as many as four if the data are consistently stronger than expected; but the higher probability is for three hikes this year and, indeed, we see a base case for a second hike in July and a third in December, with the risks skewed to the upside. ***
*** Potentially complicating the March meeting policy messaging are the rate dot projections. They come first in the policy decision process, and there is a risk the median of the 2017 dot plot could rise to four from three hikes this year if, for instance, more staff begin to pencil in additional fiscal stimulus. We, on balance, doubt the rate projections will shift enough to lift the median, but if they do, we suspect Chair Yellen will again downplay their signaling significance, reminding any who will listen that the rate dot projections are meant neither as guidance nor a commitment. ***
Locking in March
The headline takeaway from Chair Yellen’s Chicago speech, the rather overt accent on how likely an “appropriate” March meeting rate hike would be, was meant to cap what has been a surprisingly consistent and uniform Fed messaging campaign, a sense of which we tried to convey in recent reports (see, for instance, SGH 2/13/17, “Fed: March Positioning” and SGH 2/22/17, “Fed: Hello March”).
But what is perhaps most striking about the Fed’s messaging campaign was how little the forecasts changed since December. We suspect the March Summary of Economic Projections, for instance, may show at most very slight upticks in the median growth outlook if the lower growth projections are nudged up a little in the full range of forecasts before they are top and tailed for the central tendency and the median forecasts. Both the projected 2017 year-end headline unemployment and inflation rates are unlikely to change at all.
That lack of a change, however, is kind of the point to what lies behind the FOMC’s quickly forming consensus to raise rates in March. Every year that we can remember in the long slow slog to a sustained recovery, the Fed has opened the year with optimistic forecasts that then see a steady marking down through the year, beginning almost immediately with surprise low-growth first quarters.
This year was the sole exception. Data have more or less been right in line with expectations, perhaps modestly a little better here and there, and while there is no sense of a breakout or anything like that, growth is simply looking more sustainable and solid, underpinning the Fed’s growing confidence in the outlook.
And all that is coming before the anticipated Trump “reflation” is factored into the forecasts in any meaningful way. For now the Trump impact is mostly in the dissipation of downside risks that had so dominated the Fed’s policy normalization ambitions last year.
Instead, higher yields look to have done little to no damage, the dollar has held fairly steady, and the stock market has soared, all of which should support aggregate demand; financial conditions have been easing, with a rise in what Vice Chair Stan Fischer noted on Friday were the almost forgotten “animal spirits;” who knew?
One last hurdle remains with this Friday’s Non-Farm Payrolls print. But Chair Yellen set a low bar in her remarks, that payroll growth north of 75,000 to 125,000 jobs a month would be likely to continue absorbing labor market slack. So it would take a pretty shocking collapse in job creation to rattle the FOMC consensus.
In addition to the supportive data, there was a fairly strong underlying sentiment running through the FOMC these last few weeks on the tactical merits to get a rate move in earlier rather later this year, which again, we previously highlighted. The idea is to avoid the risk of needing to raise rates too rapidly, perhaps next year when the full effects of a stimulative tax and fiscal policy are stoking demand in an economy already at maximum employment and very near mandate-consistent inflation.
Another factor swaying the consensus towards another rate move was the benefit seen in maximizing their flexibility on the timing to the anticipated rate hikes through this year, something several Fed officials noted in their speeches and public remarks. A March move, for one, certainly resolves the potential dilemma over a May move bracketed by the first and second rounds of the French elections (SGH 2/15/17, “Fed: The Frexit Factor”).
Indeed, if the French elections continue to leave European political risk hanging over the markets, it provides an ideal backdrop to a March move by the Fed in tempering any spike in US yields since treasuries are the safe haven asset of first choice if everything threatens to go to hell in Europe again.
That framing of a March rate move as a “dovish hike” may not need to be as explicit as it was in the December 2015 rates lift-off or last year’s long delayed second rate hike in December. The data and diminished downside risks are providing a far better looking backdrop to a rate move; after all, if the data looked this good this time last year and there wasn’t such an overhang of global uncertainty, the FOMC would have been quite happy to hike last March.
That said, however, we do think there is a fairly strong likelihood that Chair Yellen will stress that a March rate hike does not necessarily signal an accelerated pace in removing monetary accommodation in quarterly rate hikes or four hikes this year. The press will invariably ask and we think she will push back on that front.
It doesn’t necessarily rule out a fourth rate hike this year — it really does depend on the data — but we think Chair Yellen will emphasize it is simply too early to make that a base case or to heighten its probabilities.
For now, we would tend to pencil in a continued base case rate path of three hikes in total this year that would lift the target range for fed funds to 1.25%-1.5%, or at or within hailing distance of the estimated effective equilibrium real interest rate. It would take quite a boost in the data to prod the FOMC into an outright tightening this year.
So if the data continue to track so nicely along the trendline mapped out in the forecast, we suspect the FOMC would be tempted to pass on a June rate move to follow through on a second hike this year at the July meeting.
It would be a messaging twofer, in both pushing back on an assumed quarterly pace of rate hikes as well as finally showing they really can move at a meeting without a press conference. But again, in the end it will depend on the Fed’s reading of the data and the implications of US fiscal policy.
And About Those Dots
One last point about what we discern is the most likely intended messaging takeaway from the March meeting is the potential complications of the SEP rate dot projections.
Supposedly the scariest moment in the quarterly FOMC meetings is when the rate dot projections are revealed. Fed staff have long penciled in an assumed appropriate rate path around which to build their forecasts, and at least internally, tended to be taken with a grain of salt.
But ever since their introduction in 2012, the rate dot projections have often complicated the intended policy messaging in that they come first in the policy decision making process, so adjustments often need to be made in the statement to a lesser degree and especially in the press conference if the dots are in conflict with the intended policy messaging.
Fed officials have insisted till they are blue in the face that the rate dot plots are not meant to provide policy guidance in the same way as the policy statement itself and are hardly commitments on the pace and path of the rate trajectory. The introduction of fan charts, meant to accent just how uncertain the rate projections are, may or may not help aside from adding to the general sense of confusion.
But if the median of the 2017 rate dot projections do slip up to four from three rate hikes this year, we suspect Chair Yellen will again fall back on dismissing the importance of the rate dots, as she did on the December 2015 rates lift-off with four rate hikes being on display in the SEPs for 2016.