It was not the Federal Open Market Committee’s nudge in the 2018 median rate projections to four from three hikes that took us by surprise this afternoon — it was after all a one vote margin — but rather that the FOMC opted now rather than later this year to scale up to a more hawkish policy stance.
*** The June policy messaging across the statement, the rate dots, and the economic projections certainly lifts the probabilities for a third rate hike in September to a 2%-2.25% fed funds target range. We nevertheless believe that while the data could easily preclude a tactical pause, the Fed will be cautious in weighing a fourth rate hike this year, as rates will by then be at the bottom end of the estimates for short run neutral levels, which we still think will require clear evidence of a rising underlying inflation without a fraying of the Committee consensus. ***
A Hawkish Edge to the Outlook
It had been our best sense of the FOMC consensus around the time of the release of the May meeting Minutes three weeks ago that the Committee majority needed to see a few more months of data to bolster their confidence there was indeed a sustained rise in underlying trend inflation (SGH 5/22/18, “Fed: A Honeymoon’s Second Doubts”).
The direction may have been right, but the timing was clearly wrong, so it would appear the Committee consensus was more finely balanced in its tilt than we were assuming.
We took Fed Chairman Jerome Powell, who delivered another superb performance in his under one hour press conference, to be just a tad more dovish than the impression left just thirty minutes before in the statement and accompanying projections. He must have noted what seemed a hundred times that the “economy is doing well,” for instance, which would echo earlier assertions that the Fed does not believe the US economy is on the cusp of accelerating inflation.
But although he even added at one point that “nothing since March changed our thinking on inflation,” there was nevertheless a slightly more hawkish edge to the outlook.
Core inflation was marked a tad higher to 2% from 1.9% in 2018, which in fact could have been even higher considering the sharply lower projections for the headline unemployment all the way down to 3.6% this year, and even lower to 3.5% in 2019 and 2020.
That the unemployment projections are now a full point below the (unchanged) median NAIRU estimates make it all the more surprising that the core inflation projections were held to only 2.1% in 2019 and 2020. In effect, the expected inflation behavior remains fairly inertial, just from a slightly higher level.
And on those rate dot plots, it is perhaps noteworthy that, we think, it was Chairman Powell himself whose rate projection was nudged up from three to four and thus tipping the balance inside the Committee; if correct, it would put the Chairman squarely in the center of the Committee consensus.
It was equally interesting that even the two most dovish members of the FOMC, presumably St. Louis Fed President Jim Bullard and Minneapolis’s Neel Kashkari, also moved their 2018 rate projections up, albeit still well below their Committee colleagues, but nonetheless a bit closer to the majority cone of consensus.
And along the same lines, the 2019 rate projections tightened up quite a bit around the median of three rate hikes, and even the most aggressive of the rate projections, presumably Kansas City’s Esther George, came down a notch.
Meanwhile, the median rate projections for 2020 came down by one hike, which more or less reflects the moderate flattening we were expecting in the rate trajectory. We suspect the 2021 rate dot plots, which will be unveiled in September, may show the Fed expecting to continue in its projected rate hikes rather than coming to terminal point in 2020.
It was also impressive that Chairman Powell announced so soon on what we had gathered was already a Committee consensus to commit to pressers after every meeting, starting in January, as we had previously written (see SGH 3/19/18, “Fed: Pressers”). We were thinking there could still be concern that the announcement would be hawkishly misinterpreted, but the announcement seems to have come off fairly smoothly, perhaps because Chairman Powell went to such lengths to stress it was about greater communication rather than a signal about policy.
It is Powell’s Fed Now
Fed officials have been making the “three plus” case for months, that their gradual pace of policy normalization could mean “three or four” rate hikes this year; Chairman Powell and several of his Committee colleagues have likewise been strongly hinting the time had come to revamp the guidance language in the statement.
So with the benefit of 20/20 hindsight, the nudge upward in the 2018 rate dot projections and the modestly more hawkish statement should not have been a surprise. And why not just jettison the entire guidance paragraph, including the key rates “below normal” neutral, all in one go?
As Powell explained in such soften spoken, plain English, as the Fed continues in its gradual pace of normalization, the level of rates will no longer be below neutral before too much longer. “Therefore, we thought that now is an appropriate time to remove this forward guidance from our policy statement.”
And in removing that key sentence — inserted into statement at the March 2014 meeting, the first under Janet Yellen as Chair — it not only denotes the rapid approach to a successful end to the policy normalization strategy, but it also marks the true beginning to the Powell leadership of the Federal Reserve.