Fed: Smooth City

Published on June 18, 2014

There isn’t a heck of a lot we can object to in the thrust of today’s Federal Open Market Committee statement, Summary of Economic Projections and the blue dot rate plot, and what was a smooth performance by Chair Janet Yellen in her second post-meeting meet the press.

*** This is an FOMC still confident in its forecast for a steady recovery, declining unemployment, and a trendline of inflation amid noisy data edging back to its mandate consistent levels. Growth was marked down in 2014, but reflecting a “delayed not derailed” growth, 2015 remain unchanged with a 3% plus growth projection. ***

*** Trend growth was tweaked down slightly and the longer run neutral, as we expected, showed the majority of the Committee now seeing the equilibrium interest rate between 3.25%-3.75%, south of the Taylor Rule 4%, but well above recent market chatter of an even lower 2% neutral nominal rate. ***

*** As expected as well (SGH 6/16/14, “Fed: Wednesday’s Expected Takeaways”), Chair Yellen declined to validate the ultra-dovish market pricing under a dovish Fed, but essentially dismissed the talk of higher inflation or financial stability risks. The Committee is for now focused through probably September on ironing out the details to the Exit sequencing, and Yellen pre-emptively emphasized that exit discussions (that may appear in minutes for example) do and will not reflect any shift in the expected timing of the actual exit. ***

The CTF and the Blue Dot Plot

In terms of the central tendency forecasts and the rate dots plot, as we expected (SGH 6/10/14, “Fed: Three Themes to June”), there was a sharp market down in 2014 growth, but crucially, there was no change at all for 2015 at all, still projecting a 3.0-3.2% growth, also with little change in the headline unemployment rate in 2014 and only another lurch down in the projections in 2015 to 5.4% – 5.7% from 5.6% – 5.9%.

Perhaps a bit surprising to many in the market suddenly getting worked up over a single CPI (not PCE) print and the pundit chatter over the Fed being behind the proverbial curve, the CTF showed almost no change in the inflation forecast at all across all three years of the forecast. In fact, any sign of an uptick in inflation is a long overdue and welcome development if anything.

There was an extremely small tweak down again in longer run growth range to 2.1% to 2.3% from 2.2% to 2.3%, which spilled over into an even larger decline in the longer run neutral interest rate in the blue dot plot, also expected, with only five members still at 4% or higher, with one down to 3.25% and ten now at either at 3.5% or 3.75% compared to just six in June.

Otherwise, the changes in the 2015 and 2016 rate dots were exactly as expected, with a dispersion into a longer, narrower dot plot. The four hawks went even hawkier in 2016 with rates at 3.5% to as much as 4.25% while the three uber-doves put their first rate hike in 2016 albeit rising at a 100 basis point or more pace that first year.

The centrist/dovish leaning middle of nine Committee members all nudged their dots up ever so slightly for 2015 to a range between 50 basis points on the low end to as high as 1.50%, with the center of gravity squarely at 1%-1.25% in 2015 compared to more of a 0.75%-1% center of gravity in March; In 2016, the core group are all squarely in the 2%-3% range, ever so modestly higher than where they were in March.

A Smooth Yellen Presser

And as to the press conference, Yellen simply avoided taking the bait from reporters looking to probe a bit more on either inflation worries (and especially to the upside), the significance of the lower neutral rate (hint: it ain’t a “new normal” of a 2% nominal neutral), or any nod to the continued debate of structural unemployment leaving less labor slack than assumed.

She in fact presented a fairly optimistic picture on the recovery at an above trend, near 3% growth — a highly accommodative monetary policy, waning fiscal drag, easing credit conditions, net job creation, higher house and equity prices, and even an improving global outlook, and dismissed out of hand the chatter over yesterday’s slightly higher than expected CPI print as “noisy” and that the Fed will not tolerate a prolonged period of inflation below or above a mandate consistent 2% medium target.

Along the same lines, Yellen acknowledged market volatility is at low levels — mind, the Fed has no target level in mind — and said to the extent “low levels of volatility may induce risk-taking behavior that entails excessive buildup in leverage or maturity extension” is sustained for long enough that it threatens risks to financial stability, then it would draw the Fed’s concern.

But until then, the market should be aware of the uncertainty around the outlook and so should show a little less herd-like trading, and if the market wants to price well under the FOMC’s own assumed rate path, so be it but be aware that “stuff” happens.

And Yellen seemed pleased by a late question on wage growth, reaffirming her expectations that “as the labor market begins to tighten, we will see wage growth pick up some to the point where real wage growth.” But more to the point, Yellen warned that “if we were to fail to see that, frankly, I would worry about downside risk to consumer spending.”

For Yellen’s FOMC, the weakness in wage growth remains a key policy driver keeping an eventual rate lift-off pushed back to most probably not until the second half of next year.

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