Fed: Rebuilding Communications

Published on July 25, 2016

The Federal Reserve is obviously not going to raise rates this week, but we do think it is working up its courage towards one. And on that note, perhaps the most important topic on the agenda this week will be a likely review of the Committee’s communications strategy.

*** We still believe a solid Federal Open Market Committee majority, including its Chair, are intent to raise the target range for the federal funds rate by December (this year), assuming as always that the data stays the course (SGH 7/12/16, “Fed: The Emerging Post-NFP Consensus”); they could even have a go in September, if the stars truly align and the data looks to be in fact picking up a notch. ***

*** Whether that rate hike comes in September or December, it is likely to be framed against another modest downshift in the rate dot projections at the September meeting. In other words, when that elusive second rate move comes, it will be another “dovish hike” with a further flattening in the projected rate trajectory, under the developing assumptions. ***

A Fairly Upbeat Economic Outlook

When the FOMC runs through its assessment of the current economic outlook, it is likely to conclude that things are not all that bad. 

The robust Non-Farm Payroll earlier this month cleared the uncertainty over its previous print, while a slight uptick in the the labor participation rate and some healthy wage gains further add to the sense of a still tightening labor market. That should help to boost the Fed’s faith in Mr. Phillips and the bet on a firming inflation.

Retail figures have also been good, and the update on the second quarter GDP due Friday should add to the sense of an economy on track and hardly slip-streaming into a slowing or subpar pace. 

And for all the angst over the Brexit and global risks, they look to be fading into the rearview mirror. Any Brexit fallout or God knows what else goes wrong in Europe will more likely than not extend across a longer time line, meaning its effects will be marked by tweaks to the forecast rather than triggering a marked downgrade or stopping a rate move in its tracks. 

In fact if anything, the risks abroad and capital flows into the dollar are so far easing rather than tightening financial conditions, as the drop in yields has been so far more than offsetting a stronger dollar.

It should all translate into a minimum of changes in the post-meeting statement on Wednesday, save for a more positive tone to the descriptive first paragraph on the economy. Global risks and financial developments will continue to be monitored which, of course, always are anyway.

And the statement will with near certainty repeat the Committee’s expectation economic growth will continue to plod along just above trend, warranting “only gradual” increases in rates, which will run for some time under the previous notions of a longer run “normal” level. 

Aesop’s Forewarning

Someone nevertheless quipped to us the FOMC should re-read Aesop’s Fable on the “Boy Who Cried Wolf” before they think about ratcheting up hawkish rhetoric in the run up to a meeting at which the Committee seems to find a reason for caution and a prudent pass. And indeed, the misfire of the hawkish signaling through most of May in a build up to a summer rate move, only to be forced to stand down after the surprise weak NFP print, is leaving the FOMC reluctant to rinse and repeat on that messaging cycle again.

Our sense is that the FOMC this time will be only too happy to let the data take the lead in driving market expectations and rate pricing in the coming weeks. Confident sounding messaging here and there on good data or on the merits of continued policy normalization can perhaps nudge things along. But we rather imagine most FOMC members will religously avoid getting too date-specific in their takes on the policy outlook. 

And learning her lesson from the no-show at last year’s Jackson Hole conference, Chair Janet Yellen will be giving the key note to this year’s August 25-27 conference on “Designing Resilient Monetary Policy Frameworks for the Future.” Somewhere in the speech itself or in the takeaways from the coffee break or hiking trail chatter, a sense of the near rate move timing is likely to become more distinct.

Until then, take some time off, hit the beach, go fishing. But assume that this is an FOMC that truly leans towards a near term rate move, whose probabilities are certainly higher than current market pricing. 

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