Fed: Redefining Gradual

Published on June 15, 2016

Our first reaction to the plunge in those rate dot plots and Chair Janet Yellen’s press remarks this afternoon was to reach for our Thesaurus to look for another word or words to describe a much slower version of “gradual.”

Harvard University professor Larry Summers would no doubt helpfully suggest “secular stagnation” fits the new definition.

*** The 2016 median rate dots did barely stay at two hikes this year, but Chair Yellen did not exactly push hard to keep a July rate hike on the table — “it is not impossible,” she offered hesitantly¬† — and not even Kansas City President Esther George could bring herself to dissent this time. The probabilities now seem to lean towards a September next move. ***

*** The data could offer a rare clarity in a strengthened pace of economic activity and a rebound in a continuation of a tightening labor market over the next few weeks. That would keep a July move on the table, but the odds nevertheless do seem to be receding across the FOMC, which is probably a good thing since the market is now pricing in the next rate hike for the end of next year. ***

Uncertainty Across the Outlook

The statement was more or less as widely expected, with all the tweaks to the first descriptive paragraph of economic conditions: the gains in the labor market slowed, but economic activity picked up, the unemployment rate declined but job gains diminished; household spending is stronger and housing is still getting better, and the drag from net exports is diminishing, but business fixed investment has been soft, to say the least.

The Cliff Notes version of that is “uncertainty.”

The FOMC also acknowledged market-based measures of inflation expectations have declined, but they still insisted that the more important survey-based inflation expectations were¬† “little changed, on balance.” And Chair Yellen did acknowledge that the UK Brexit vote did factor into the policy decision.

This year’s real growth in the Summary of Economic Projections were marked down as expected to 2% from 2.2% in March and 2.4% in December. And while the median trend growth projection remained at 2% — which we assume means there isn’t much momentum left to tighten the labor market — but in the range of longer run projections, one or more were marked all the way down to 1.6%.

The Dramatic Dot Drop

But the real takeaway from today was all about the dots and the significantly lower and slower pace of the projected rate path over the next few years.

Almost as telling as the drop in the rate projections for 2016 to barely two, the rate dot projections for 2017 and especially 2018 likewise dropped as we expected, but by even more than we suspected they would. It is noteworthy that none save but a handful of the more hawkish projections are now anywhere near the presumed longer-run neutral rate.

What’s more, the projections for a longer run neutral nominal policy rate also saw a pretty dramatic drop, again, by even a bit more than we expected (SGH 5/4/16, “Fed: Burden of Proof”). The median is now all the way down to 3%, with only three of the more hawkish hanging in there up at 3.5% or 3.75%.

A Slowed Policy Normalization

So the pace of the rate tightening being mapped out in the policy normalization path looks by all accounts to now be very gradual, and one that will extend beyond the three year forecasting horizon of the SEPs to maybe four or five years from now. That is unprecedented.

The lower and much slower path of policy normalization does leave us a bit curious, however, how the Committee will be reading labor market slack and the recent signs of upward wage pressures. Core inflation, for instance, was modestly marked up for this year to 1.7% from 1.6%, but there is still no rapid climb in those price pressures through the end of 2018.

So either inflation will remain largely inertial in its slow ascent, or else judging from the new rate dot plot, the Fed really does believe in a temporary, smallish overshoot of the symmetric 2% inflation target after all.

But the biggest, oddest curiosity of the afternoon must surely be that low rate, extreme outlier in the rate dot projections with but a single rate hike across all three years of the forecasting horizon. The ghosts of Narayana Kocherlakota must linger in the Committee room.

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