Communications will loom large for markets in the take away from next week’s Federal Open Market Committee meeting, both in the statement itself and in setting up the likely policy messaging through the dog days of August and into the pivotal September 16-17 meeting.
*** In the statement itself, we expect the main FOMC policy signal to be in an upbeat take on the economic outlook in the descriptive first paragraph, which would be in line with the FOMC’s “data dependent” mantra. That said, however, in addition to the “below normal” sentence on the neutral interest rate to indicate the likelihood of a gradual trajectory, we suspect the Committee may also consider including a non-calendar specific reference to the “sooner and gradual” rate hike argument laid out by Chair Janet Yellen in her speech just before the Humphrey Hawkins testimonies earlier this month. If that “sooner” argument fails to make the communique, we believe it will be almost certain to appear in the Minutes released on August 19. ***
*** Beyond July, we expect the Fed messaging to follow the lead of what the Fed expects to be the “good enough” data of a tightening labor market that lends to a “reasonable confidence” in the forecast for higher inflation, with policy that “operates with a lag” — meaning the Fed will need to start a “normalization” of policy well before inflation is moving to 2% — and a prized “policy flexibility” as two themes that are also likely to dominate the narrative. But in a vacation-filled August, some of the final heavy-lift in the Fed’s policy messaging may be left to the August 27-29 conference in Jackson Hole. ***
*** On balance, assuming the usual but critical caveats about the data, we still believe the FOMC is more likely than not to raise the fed funds target range at its September meeting (see SGH 3/18/15, “Fed: September and a Shallow Path”). Our sense continues to be that the Committee’s bar to a first hike is fairly low, and that a Committee majority is increasingly seeing the balance of risks tipping in favor of the “sooner and gradual” start to policy normalization, both to avoid the risk of potentially needing to raise rates more rapidly and to better ensure a gradually sloping rate tightening trajectory. ***
The July Statement
When weighing what to expect from the FOMC next Wednesday it is worth keeping in mind that the era of formal policy guidance came to an end in the March statement when the “patience” language was dropped. Fed officials since then have tried to lean hard on a far less explicit “data dependent” messaging, its intention to “normalize” market expectations and shift its pricing away from the remarks and signals of the Fed officials themselves to the data.
Before any first rate hike and all that it carries with it in signaling a regime shift, the Fed would ideally want a period of at least six months or more of a two way trading in the market, and a bit more volatility, (albeit not all in a day)! After all these years at the Zero Lower Bound, Fed officials now need to garner as much in signals in yield levels, term premiums, and spreads in the market trading as the market has been taking in cues from the Fedspeak and the FOMC’s forward policy guidance of the last few years. Normalization cuts both ways.
It would be somewhat problematic, then, for the FOMC to revert back to more explicit signaling in its post-meeting statements, and so we expect little guidance in next week’s statement towards September or any month for that matter, in terms of the timing to a first rate hike.
Along those lines, we expect most of the Committee wordsmithing in next week’s statement to come in crafting the language in the opening paragraphs of the statement describing the evolution of the economy since the last meeting and the near outlook. We would not want to second guess the polish of the English majors among the Committee and senior staff, but since the recent data has been pretty good, we would expect the language to be pretty upbeat and to indicate a higher level of confidence in the near term outlook.
The statement will, however, still include the one bit of forward guidance that is a cornerstone of the Fed’s likely policy path under Chair Janet Yellen and repeated in every statement since March last year, that the Committee expects to keep rates “below levels the Committee views as normal in the longer run” even after employment and inflation are near mandate-consistent levels. We have gone into the reasons for the likelihood of that gradual, shallow trajectory, so there is no need to go into it again here (see SGH 5/12/15, “Fed: A Hawkish Lift-off, Dovish Trajectory”).
All that said, however, we suspect there will nevertheless be some consideration given to adding a sentence affirming the shifting balance of risks seen, we believe, by a majority of the Committee in favor of moving on rates “sooner” and the burden of proof increasingly falling on those members making the case to wait on a rate increase until “later” and into 2016, essentially, to safeguard against the persistence of low inflation and the difficulty of reversing from a first rate hike.
Among a majority of the Committee, however, our sense is that the greater merits are still increasingly seen in a “sooner and gradual” rate path. It is the best means to ensuring greater policy flexibility to respond to the incoming data or significant changes in the forecast, and above all, to avoid the potential need to raise rates more rapidly down the road in the unlikely event of wages or inflation rising faster than expected, or more to the point, the market reacting violently in repricing the Fed being seen as behind the proverbial curve.
That Chair Yellen referred to the “sooner and gradual” argument in her speech earlier this month just before her Humphrey Hawkins testimonies, and repeated it again in one of the Q&A sessions, is telling. Indeed, for Chair Yellen to assert on Capitol Hill that the “the economy cannot only tolerate but needs higher rates” should not be under appreciated, however skeptical the market is of the Fed ever raising rates.
August and into Jackson Hole
If the “sooner” language doesn’t make it into the formal statement next week — and the consensus may not be there just yet admittedly — it certainly will in whatever speeches there are by Committee members in August and early September. And in any case, an extensive discussion over the balance of risks between “sooner and gradual” versus “later and steeper” are almost bound to show up in the subsequent Minutes three weeks later.
And while on the Minutes, with the month likely to be thin on Fed speeches – who in their right mind isn’t going to be taking some time off while they can? – they may carry even more of an out-sized importance in providing glimpses into the FOMC thinking and points of consensus when they are released on August 19.
That also happens to be about a week before the Federal Reserve Bank of Kansas City’s annual conference in Jackson Hole.
There have been some discreet efforts by Fed officials to play down the elevated status of Jackson Hole, which has come to carry the near status of a FOMC meeting. Former Chairman Ben Bernanke skipped attending a few years ago, and Chair Yellen is doing so this year. We suspect that may in part be due to a desire to keep the market away from hanging on her every last word as its sole guide to gleaning the odds on the timing to a rate hike.
But the fact remains, whether Chair Yellen is there or not (Vice Chairman Stan Fischer is scheduled to give the opening keynote speech), the days there in the shadow of the Grand Tetons do provide an ideally timed forum for Fed officials — many of whom attend — to chat among themselves and to mingle with the press and academics.
We suspect, then, by the end of that weekend, a consensus of sorts, for both the FOMC and in market expectations is likely to come into view on the likelihood of a September rate hike, or whether caution is pushing the start to policy normalization back. But as we have been writing, we think the scales will tip towards the former, with the last Nonfarm Payroll print in early September all but confirming the probabilities.
In an ideal world though, Jackson Hole will come after a string of reasonably strong data prints that will already be slowly edging the market up in its pricing for a rate hike on the near horizon. Indeed, decent data may do much of the talking for the Fed and, after all, that is the preference and logic of the shift away from forward guidance to the data-dependent messaging.
So if the FOMC should be so lucky, the data will be sufficient enough and the forecast confidence high as necessary to undertake a first rate hike, we think as soon as September, and as a follow through and validation of market pricing rather than a harsh re-set to market expectations with all the volatility that it may bring. And what are the odds on that?
Even while economists in polls are increasingly coming around to the chances of a first rate hike in September, those odds are still roughly stuck at around 50:50. And the ever skeptical markets, for their part, are putting far less money on the odds of an actual move by then than that.
Incidentally, one other issue that is likely to figure high on the July meeting agenda is an operational review of whether the Desk in New York has the necessary tools and can indeed pull and push the effective federal funds rate up inside a new target range when the moment finally arrives for a first rate hike and the start to policy normalization. On that, until we hear otherwise, we assume the New York staff will chant “Yes we can!” in reply.