Fed: Further

Published on January 31, 2018

As might be expected, there was a dead minimum of language changes to the January Federal Open Market Committee meeting statement this afternoon.

*** But the tweaks, however subtle to the point of being nearly invisible, are nevertheless important in shaping the early contours of the policy options under the incoming Chairman, Jerome Powell. In other words, the language changes to the statement — and to the Statement on Longer-Run Goals and Monetary Strategy — were not so much about whether they were hawkish or dovish signals as much as they were about creating maximum policy flexibility through at least the first six months of the Powell chairmanship. ***

*** A March rate hike remains far more likely than not (SGH 12/18/17, “Fed: Into 2018″). But beyond a March marker, our sense is of a wider than normal uncertainty band around the three hikes base case for this year, with two hikes still possible even as markets eye the prospects for four. The hikes beyond March and especially next year will depend not just on how the data play out, but on the internal debate over R* and on the need, if any, of moving away from the gradual pace of normalization once the policy rate is safely up to the effective neutral level. ***

Upward Tweaks to Inflation but Not to Risks

Dialing back to the statement, the FOMC acknowledged the steady improvements in the economic performance as could be expected, and they did hawk up the inflation language ever so slightly: they noted overall and core inflation have no longer “declined” and those measures have instead simply “continued to run below 2 percent” — which is another way of saying the low inflation may have bottomed out.

Likewise, the market-based measures of inflation compensation have actually “increased” even if they do remain low, which, again, is a nuanced way of suggesting the mysterious downward turn in inflation may be reversing.

So while modestly hawkish in isolation, on the other hand, the Committee chose not to change the “roughly balanced” near term risks to the outlook language. They could have in fact easily dropped the “roughly” in the December statement and so could have just as easily done so this month in light of the assumed boost to aggregate demand on the way due to the tax cuts and further boosts to federal spending.

But more likely, the Committee probably did not want to go too far in sending such a more overt hawkish signal, and they are probably saving the change to the risk language for March, to coincide with a rate hike.

That balanced risk language would then in turn stay in place for much further down the road, perhaps being adjusted upward again to upside risk in the outlook if they are at the point of hiking beyond the presumed neutral level in an outright rate tightening.

Dovish Tweak to the Strategy Statement

Along the same lines in backing away for now from an upward change in the risk balance assessment was an interesting and far less noticed dovish tweak to the attached “Statement on Longer-Run Goals and Monetary Strategy.”

The strategy statement is revisited annually every January, and is supposed to be rarely changed, and only with a solid Committee consensus. So when the estimated longer run unemployment level was marked down to 4.6% this January from 4.8% last year, it is not without significance down the road in that it could imply a more dovish view on the pace of rates normalization or its end point.

In some sense, it is merely an acknowledgement of the drop to a median 4.65% in the longer run estimate in the December Summary of Economic Projections. But a tweak to the quarterly SEPs is one thing — making its way into the “holy sanctity” of the longer run statement is an altogether more significant change.

Indeed, a dollar wager would be that the longer run tweak in the strategy statement was a trade-off to the modestly upward language changes in the description of inflation in the statement.

That Curious “Further” Insert

And finally, there is that curious “further” qualifier inserted into the gradual pace of rate increases sentence: it is so mild, so faint to the naked eye it is almost invisible, but if it meant nothing, then why drop it in? Twice?

One can assume it was meant to simply indicate a progression of more rate hikes are coming, so perhaps a modest pushback against the “two and done” sentiment that is out there in the market.

Probably more to the point, given the range of views within the Committee, “further” could have different meanings for different members of the Committee.

Indeed, with some poetic license to be sure, we also took the inserts in the guidance paragraph to mean “just a bit further” or “nearly there,” and we linked it to how close the FOMC believes they are getting to the effective neutral rate.

Perhaps it is because we had skimmed so quickly past the second “further” insert — in what is the guidance paragraph — to the bedrock sentence since March 2014 that “the fed funds rate, for some time, is likely to remain below levels that are expected to prevail in the longer run.”

At some point, that sentence will be coming out, if the Committee still believes R* will be slowly rising to its longer run levels as the economy improves and the policy transmission channels become unclogged.

And the moment that will be under review is when the FOMC confidently believes they are at or near neutral. For more than a handful of the Committee if not a majority, it offers a moment to take a lay of the land, an assessment of the economic outlook, inflation pressures, and the latest view on R*, that could lead to a change in the gradual pace of rates normalization.

Probably more to the point, the “further” inserts and the overall very modest tweaks to the phrasing were meant to both keep an upward tilt in market pricing expectations, but also to buy some time before the questions over the pace of rate normalization, the inflation dynamic, or whether the corporate tax cuts could indeed lead to productivity-enhancing investments, become a bit clearer “further” down the road.

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