One could be forgiven for thinking we have been here before. This year opened as each of the last few years did, with a heady optimism on the outlook and market bets on which month the Federal Reserve will raise rates after the years-like-eternity at the Zero Lower Bound.
But then, yet again, steady downward revisions have disrupted the storyline. And here by the time of the Federal Open Market Committee’s April meeting, both the Fed and the markets are awaiting data to signal whether the economy is bouncing back from its first quarter southern turn or if it is indeed settling back into a subpar pace nearer to 2% or less.
*** That uncertainty all but ensures few if any changes in Wednesday’s FOMC statement. The Committee will acknowledge the slower first quarter growth, but within the same breath that it is likely to prove transitory. That translates into expectations of unemployment falling steadily through the year and low inflation persisting but still picking up next year. A “below normal” neutral rate will still feature, but otherwise a post-April, data-driven policy outlook is all that will remain of the forward guidance. ***
*** Although the statement will not explicitly indicate anything about June, we continue to think the odds of an early summer rates lift-off are very low. And while the recent lackluster data obviously raises the odds for a December lift-off, we still think September (this year!) remains the Committee’s base case. Indeed, despite New York Fed President Bill Dudley’s recent “hopeful” hedging, we suspect the FOMC will stick to the September base case through at least early summer unless far softer data forces its hand. ***
*** A September 2015 rates lift-off, we think, is as much driven by a desire to protect a very gradual, un-measured” pace of rate hikes as it is how the data feed into the near forecast. An FOMC majority still believes moving a little sooner than the data might suggest, avoiding the need for rapid rate hikes that might spook the markets or derail the recovery, is the best insurance to extending the economic expansion and stoking a higher trend growth that blunts the threat of deepening secular stagnation. ***
Mr. Dudley’s Hopes
New York Fed President Dudley’s remarks on the eve of the pre-meeting blackout that he “hoped” the Fed would be able to raise rates this year caught the market’s attention since it seemed to confirm the market skepticism and more dovish expectations.
But it is our sense that that while he was essentially confirming the extremely low odds for a June first move — the May data would have to surprise very strongly to the upside — Dudley’s intended takeaway was not so much about taking September out of equation as it was a twofold reinforcement of the Fed’s new central message since the March meeting.
That message was, first, that policy from here will be based on a meeting to meeting assessment of the data and the changes to the forecast, and that second, the rate hikes, once underway, will not be on any pre-set, predetermined path. That the softer language would help slow the pace in the rise in the dollar may have also been a hoped for effect.
That new March messaging template also means the FOMC is all but certain not to tinker with the forward guidance this week. After all the effort to move off the calendar-specific guidance, the Committee would hardly reverse gears to shift back to the more explicit guidance, even if the data was falling through the floor.
And while the recent numbers have not been great obviously, the Fed’s assumptions on an underlying momentum almost ensures this coming statement will steer clear of any new policy signals other than the descriptive updates to the economy, and that the Fed is taking the current softness as mostly transitory.
The slower growth will be acknowledged, and we do think the Committee will also at least acknowledge the stronger than expected impact of the dollar on domestic economic activity, and perhaps that the boost from the lower energy prices has yet to fully realized, but which should eventually be played out in stronger demand data.
For the most part, a majority of the FOMC honestly do not appear to believe the data will be so weak through the second quarter and into the summer that it would push the lift-off into December. Those numbers, then, would have to truly taper south, and for several months, before the Committee would abandon its assumptions of that underlying momentum that should start showing the economy rising back to its near 3% pace by the time of the June meeting.
We in fact suspect that even if the expectations prove wrong or slow in coming for the spring time snapback, the Committee’s most likely rhetorical reaction will be to put an accent on an even slower, flatter trajectory before they abandon the September lift-off and push it back to December or into 2016.