Do you have questions about those damn dots?
Are you as confused as Janet Yellen claims to be about what low inflation means for the policy trajectory?
Are you wondering if we got anything at all about the balance sheet yesterday that we didn’t already know?
And perhaps most importantly, did you stay up all night agonizing about what Goldman thinks (“where is Ja?!“)?
Well worry no more because below, you can find Goldman’s Q&A on the September Fed meeting which should definitely clear up all of your questions, although now that Cohn has proven himself unfit to be the next Fed chair by virtue of not being racist enough for Donald Trump, the bank’s long-term outlook may not be as prescient as it would have been had Gary been installed as Eccles overlord.
Q: Will the FOMC hike the funds rate in December?
A: Yes, probably. Fully 12 out of 16 FOMC participants–the same number as in June and almost certainly including the leadership–think another hike this year looks appropriate. Given the calendar, this amounts to fairly strong forward guidance for a December hike. Consistent with this, the committee upgraded the 2017 growth outlook from 2.2% to 2.4% and lowered the 2018-2019 unemployment forecast from 4.2% to 4.1%. And Chair Yellen again downplayed the significance of the weak core inflation data this year, saying that this “primarily reflects developments that are largely unrelated to broader economic conditions” and “as long as inflation expectations remain reasonably well anchored [these developments] are not a concern because their effects fade away.” Given this relatively strong message, we have increased our subjective probability of a hike in December from 60% before the meeting to 75% now. A hike is not assured, but we would now probably need a meaningful downside surprise in the inflation data relative to the Fed’s reduced expectations and/or a big market deterioration to forestall it.
Q: Was the longer-term message similarly hawkish?
A: No, on the contrary. The longer-term dots moved down by more than we (and we think most others) expected. The median pace of hikes was unchanged at three for 2018 but fell to just over two in 2019, and the longer term funds rate came down from 3% to 2.75%. Again, these moves were consistent with the message from Chair Yellen in the press conference. She said that the neutral real federal funds rate, r*, had fallen substantially and was likely to remain low, rising only to 0.75% in the longer term. And she also said that the risks to the (actual) path of the funds rate relative to the modal forecasts in the dot plot were tilted to the downside, rationalizing the very depressed market-implied path of the funds rate, at least in part.
Q: If the message was so mixed, why did the bond market take today’s news as clearly hawkish across the yield curve?
A: Three reasons. First, the dots represent a form of forward guidance in the near term–especially this late in the year, when a 2017 hike would almost certainly occur in December–but are only an opinion in the longer term, albeit a well-informed one. Second, the committee will see a substantial amount of turnover in coming years, and new participants could come with very different views. And third, the dots remain considerably above market pricing, even after Wednesday’s downward revisions.
Q: Are you lowering your own longer-term funds rate projections along with the FOMC?
A: No, we have kept our working estimate of the terminal funds rate at 3¼%-3½% in nominal terms and 1¼%-1½% in real terms. We are more skeptical than the committee that the notion of a depressed neutral funds rate is a useful concept for predicting monetary policy in the medium and longer term. It may well be that r* will remain below the historical norm, and our projections do, in fact, build that in to some degree. There is a solid economic rationale for the idea that lower potential GDP growth should imply a lower equilibrium interest rate. But while the idea is intuitive, the empirical support for it is weak–much weaker than assumed in the well-known Laubach-Williams model of equilibrium interest rates as well as large swaths of the current macroeconomic debate. So we would put less weight on that link in projecting interest rates several years into the future, and more weight on the historical average real rate of about 2%.
Q: Any surprises on balance sheet normalization?
A: Not as far as the near term is concerned, but Chair Yellen indicated that the hurdle for stopping balance sheet rolloff is very high indeed. Our read of her discussion in the Q&A was that full reinvestment would only resume once the committee had cut the funds rate back to the effective lower bound. This would be consistent with a sentence from the March 2017 FOMC minutes that read: “A number of participants indicated that the Committee should resume asset purchases only if substantially adverse economic circumstances warranted greater monetary policy accommodation than could be provided by lowering the federal funds rate to the effective lower bound.” In the March 2017 minutes, this view was still contrasted with an alternative view held by “some” that reinvestment should resume before the committee returned to rate cuts. But Yellen’s comment today suggests that at least the current FOMC thinks balance sheet normalization is now truly on “autopilot”, barring a very bad economic outcome.