The window for a rate hike at the Federal Open Market Committee’s upcoming September 20-21 meeting has all but closed in the absence of firmer, clearer Fed messaging before the pre-meeting communications black-out. And the modestly softer data is probably enough to tip the Committee balance back to a hold, even if only for the poor optics.
That puts the focus this Wednesday on the likely “hawkish hold” messaging we think Fed Chair Janet Yellen and her Committee colleagues will try to deliver in the policy statement, the Summary of Economic Projections and the rate dot plot, and above all, Chair Janet Yellen’s press conference.
A few points on what we think will be the likely takeaways this Wednesday:
** It remains our sense the recent relatively softish data is not going to push the FOMC away from its consensus for a second rate increase before year-end, which means December since November is near out of the question (SGH 9/13/16, “Fed: The December Fallback”). That will translate into the “hawkish hold” framing of a pass on a rate hike and the messaging to begin preparing the market for the long runway to an eventual December hike, assuming the data behaves to the forecast.
** It will be a tricky if not complicated messaging, with most of the heavy lift probably falling on Chair Yellen in her press conference: a too hawkish tone would raise the question of why they didn’t just hike and be done with it, undermining credibility (further), while leaving the rate probabilities too vague could stoke market complacency and potentially raise the costs when the Second Coming of a rate hike finally arrives.
** We suspect Chair Yellen will note the cumulative gains in economic activity and just how close the Fed is to meeting its mandate on employment, as well as her confidence, all else being equal, that inflation is “conforming” to the forecast of rising steadily towards its 2% target. To keep the market’s pricing probabilities in line, Chair Yellen may provide a better framing to the Fed’s reaction function to the upcoming data, assuming it stays on track to the forecast.
On the statement:
** We think it is likely to be modestly updated with a still upbeat descriptive first paragraph on the economic outlook, perhaps citing those cumulative gains in the labor market to offset any overly dovish interpretation if the pace of job gains is seen as”stabilizing” rather than being “strong.” The inflation sentences are likely to remain unchanged, while the “diminished” near term risks to the outlook sentence will or should probably come out altogether.
** The FOMC could return to the balance of risks language in this statement, that they are “near balanced” as the easiest way to convey a hawkish tilt going forward. “Balanced” risks would feel like a step too far (i.e., then they should have hiked), and there will certainly be nothing like last October’s “at the next meeting” language that all but teed up the December rates lift-off.
** We would also wonder whether the FOMC wordsmiths might instead try their hand at new forward looking language altogether rather than falling back on the risk balance framing. Perhaps they might go for something in the statement along the lines of what Chair Yellen may stress in her press conference about the economy being at or near the Fed’s mandates on full employment and inflation as a signal of more hawkish expectations on the near rate path.
On the rate dot plots:
** We are pretty certain the 2016 dots will show a vast majority, if not all 17, of the Committee members marking down a single rate hike. We would be surprised if there were more than two “no hike” dots, and we should be very surprised if there were more than three “no hike” dots showing up in the 2016 rate projections. We do think Chair Yellen is a “one dotter.”
** Beyond this year, the main work of the rate dot plots will be to convey just how dovish the overall path is likely to be beyond the probable single rate hike later this year. So the rate dot plots for 2017 and across the rest of the forecast horizon into 2019 should display a shallow, ever so gradual, pace of rate hikes for an unprecedented assumption of a five year tightening cycle.
** The other more important takeaway from the dot projections is likely to be the further consolidation of the longer run neutral estimates at or just below the 3% nominal level. The steady downward drift towards an embrace of secular stagnation in the assumptions on how high the terminal point may be in this tightening cycle continues to be one of the more remarkable shifts in the Fed’s policy path.
** The median of the 2017 rate dots may come down to two hikes from three. We suspect, though, that while some rate dot projections will indeed be sliding further down, at least a handful of the rate dots may stay where they were or even be nudged higher on fears of higher inflation with such low trend growth and a lousy productivity outlook. The 2017 dots, in other words, may look more dispersed and elongated.
** Further out into 2018 and 2019 we would be a little uncertain what the rate dot plots might look like, other than that they will probably top out near or above the median of the longer run neutral rate. In any case, we don’t really take the outer year rate plots too seriously, since few at the Fed do either.
And on the SEPs:
** The 2016 growth forecast may get nudged down again to under 2%, or at least the full range of forecasts before being topped and tailed into the central tendency are likely to be edging lower. Inflation projections will remain the same across the forecasting horizon, while we would think the unemployment forecast may edge lower this year.
** But the more interesting tweak to the SEPs may come in the trend growth median slipping further to perhaps 1.9% or even 1.8%. Though less likely just yet, longer run unemployment estimates may also come down to perhaps 4.7%. Both would be dovish signals, but probably saying more about how gradual policy normalization can afford to be rather than the timing to the next hike.
And two last points:
** One question is whether the FOMC could present the SEP and rate plot medians as fan charts like the one Chair Yellen included as a footnote in her Jackson Hole speech. We do doubt it, as it would probably add to the complications of what is already going to be a difficult messaging, but it is an interesting thought for what may come a bit further down the road.
** And finally, one last thought about Wednesday’s outcome is whether or how the FOMC tweaks their messaging in the wake of any market volatility in response to the Bank of Japan’s highly uncertain policy decision, which will have moved across the wires before the FOMC gets back to the big table Wednesday morning.
The BOJ factor further complicates the task for Chair Yellen in her post-meeting press conference — no wonder she dislikes them so — but on the other hand, it probably helps to solidify a cautious consensus within the Committee to play it safe this week and signaling the market a December rate move is on the policy radar screen.