We would normally hesitate before revisiting the debate over potential language changes so close to the Federal Open Market Committee’s December meeting statement this Wednesday afternoon, especially amid renewed volatility in the aftermath of the Russian ruble free-fall and its repercussions across global markets.
But so much has been made over the impact of plunging oil prices or the disconnect between the Fed’s blue dot rate projections and the persistence in the market’s far more dovish pricing that a late comment seems warranted.
*** First, for all the market commentary over the negative consequences in the dramatic drop in oil prices, the Fed still sees it as far more of a net and growing positive to US growth than any lasting impact in the hit to the oil-patch or to energy-related junk bonds; the FOMC is likely to acknowledge downside growth and instability risks abroad as well as near term disinflationary pressures, if not in the statement certainly in the presser, but is likely to frame the risks as limited in impact with base effects fading through 2015.
*** Second, albeit with an eye perhaps on global risks, the FOMC’s policy attention will still be primarily focused on the current momentum to US growth going into next year. It can be expected to further push the headline unemployment rate to some estimates of NAIRU before the end of next year, with a more sustained-looking wage growth starting to show up in the labor market data by mid-2015 that, in time, should slowly push inflation back to a mandate-consistent level.
*** Somewhat paradoxically, the December 2015 blue dot rate plots may show a modest downward nudge and slightly tighter dispersion in the core cluster of year-end rate projections, but less in reaction to what will probably be slightly lower inflation projections or pessimism over international spillover, as it would be a reflection of greater certainty over the 2015 forecast and the nearing lift-off and rate path.
*** So in terms of the most likely next steps towards policy normalization, our sense remains for a building FOMC two-fold consensus for a June rate lift-off (with some insurance cushion in potentially being pushed back to September) and for a pace in the tightening that is likely to be very gradual, probably marked by extended pauses in an arc across a far longer cycle than in either 2004 or 1994 (see SGH 12/11/14, “Fed: The Case for June”).
*** And while our sense going into the black-out period was of a probable FOMC majority fearful of sending an unintended hawkish signal in taking the loaded “considerable time” language out of the December statement, we suspect there has been a shift since then going into the meeting despite the obvious eye on international risks: against the backdrop of the handsome data, still anchored inflation expectations, and the market’s still very dovish pricing, the Committee balance is probably now tipping towards dropping the ” considerable time” phrasing as being past its sell-by date.
*** If replaced with some formulation of the fresher “patience” language that has already been well telegraphed in speeches and prior Minutes, Chair Janet Yellen could also use the post-meeting presser to begin defining its meaning in a more data-dependent rather than time-contingent way. But we also suspect she would pitch the changes as somewhat limited just yet in their policy signaling significance, instead reflecting more of a need to update the statement’s template to better carry the evolution of the guidance through next year when the FOMC expects to move towards a “normalization” in rates.
*** The FOMC wants maximum policy flexibility in case the data deviates too far to either side of the central tendency projections. Therefore the forward guidance may incorporate language in the statement or presser that “clarifies” that this assumed pace could run “faster or slower” depending on how the market reacts to the Fed’s initial rate moves, just as the projected rate lift-off could come “sooner or later” depending on how the near data unfolds. The equilibrium interest rate is still likely to run “below normal” relative to its longer run neutral level, though that is not the same as the terminal rate, nor will the rate tightening necessarily end in 2017.
*** If truth be told, the communications dilemma the Fed will be wrestling with this week is largely of its own making — Memo to Vice Chair Stan Fischer and his communications subcommittee: Chair Yellen needs to hold pressers after every meeting – but the risk in a hawkish mis-reading will be offset somewhat by what we suspect will be a modest (if any) downward nudge in the main cluster of the Summary of Economic Projections so-called “blue dot rate plots.” And if needed, Chair Yellen can always use the presser to find the right soothing words to balance the overall market takeaway.