Well, the reviews are in on the Fed decision, the SEP, the dots and on Jerome Powell’s “plain speak” presser debut.
Probably the best title I’ve seen is this one, from Wells: “Mix and Match.”
As you’ve probably picked up on by now, I’m not particularly enamored with Powell’s “performance.” It came across as simultaneously shaky and blunt, two things that don’t naturally occur together when it comes to public speaking. If you wanted to be generous, you could say that “shaky and blunt” is just another way of saying “more dovish than expected but just hawkish enough to be some semblance of consistent with his testimony on Capitol Hill.” But again, I think that would be a generous interpretation.
Simply put: I don’t think that’s a great combination because it sets the stage for a future meeting at which he’ll attempt to deliver a straightforward, no-nonsense assessment in a manner that suggests he’s acutely aware of his own inexperience when it comes to the academic underpinnings on which these assessments are usually made. I keep hearing that’s a “good” thing – that we need less academic rambling and obfuscation and more data-dependent decision making. That may well be the case in a perfect world where the market was still a market, but that’s not the world we live in. We live in a world governed by a constant, real-time exchange between markets and policymakers and I argue that part of maintaining that communication channel is policymakers preserving their capacity to lean on nebulous theories in order to justify pacifying markets. Paradoxically then, too much “plain speak” could create less transparency to the extent it’s indicative of a more strict adherence to the data (and less dependence on the S&P) when it comes to making policy.
Anyway, all of that is obviously debatable and we’ll have to see how that debate plays out going forward.
For now what we know is that the near- to medium-term growth forecasts were upgraded while the long-term growth outlook was maintained and the most recent data was acknowledged as having “moderated” (in the statement). We know that the committee is now forecasting a modest inflation overshoot in 2019 and 2020. We know that the unemployment path was revised aggressively lower and that the disparity between the outlook for unemployment and the projected uptick in inflation further underscores the notion that the models are broken. And we know that the 2018 median dot still calls for a total of three hikes even as the longer-term rate trajectory is now steeper.
Ok, so what does Wall Street think? Well, we’re glad you asked. Below, find a smattering of opinions that may or may not be useful to you.
Economic projections submitted by the 15 FOMC members showed a further upgrade to the trajectory for real GDP. This is now forecast to expand cumulatively this year and next by around 1.5% above its estimated trend rate, pushing the unemployment rate down by a further 50bp to 3.6% – almost 1% below the FOMC’s median estimate of NAIRU. Against this backdrop, and for the first time since the start of the upswing, the Committee expects core PCE inflation to rise modestly above target over the coming 2-3 years. Consistent with the greater confidence over the medium-term economic outlook, and a build-up of inflationary pressures, the FOMC now see scope for a more prolonged tightening cycle, albeit still much slower-paced than the 2004-2007 one. The median ‘dot’ for end-2019 rose to 2.875%, implying three hikes in 2019, and the median ‘dot’ for end-2020 now stands at 3.375% – a further two hikes, bringing the Funds rate upper bound to 3.5%, above the median estimate of the neutral rate (now at 2.9%) and in line with our US Economics team’s forecasts. At his first press conference, Fed Chair Powell softened the message conveyed by the steeper ‘dot plot’, by stressing the data dependency of the FOMC’s deliberations, arguing that the Fed can still afford to take a ‘middle ground’ in monetary policy normalization. In remarks offered in support of a continuation of a gradual tightening stance, he stated that “the relationship between changes in slack and inflation is not so tight” and that so far there is “no sense in the data that we are at the cusp of an acceleration in inflation”. This helped bonds recover after an initial sell-off.
More interesting were the updated economic projections and the dot plot, which revealed increased optimism about the prospects for growth and inflation. Consistent with the improved outlook, there was an upward shift in the median trajectory for the fed funds rate through 2020 and in the longer run, suggesting a higher terminal rate. Importantly, the median dot held at 3 hikes for this year. So while policy turns slightly restrictive in 2020 with a peak rate of 3.375%, the pace of hikes remains gradual, particularly in the near term. In our view, this means that the Fed is not looking to choke off the recovery and is comfortable with inflation above target for a period of time, emphasizing the symmetry of the target. This is consistent with our baseline forecast for the Fed to hike three times this year and next with a gradual move higher in estimates for long-run R*.
Chair Powell also sounded a bit more open to the idea of holding more frequent press conferences. As we have long argued, we believe the rates market should assign greater odds to the potential for more frequent press conferences in order to emphasize the fact that every meeting is live. While Chair Powell noted concerns that holding a press conference after every meeting could risk signaling a faster path of hikes, making such a move would seem a reasonable strategy if the Fed only wanted to raise rates three times this year and avoid potentially lifting rates at a non-press conference meeting.
The Summary of Economic Projections shifted in a hawkish direction. Interest rate projections moved higher with the median “dot” rising for 2019, 2020, and the longer-run. The 2018 median rate projection was unchanged, showing 3 hikes, but was only one participant shy of moving to 4 hikes. Projections for GDP growth and unemployment also changed to reflect the impact of fiscal stimulus. The median growth projection was upgraded 20bps in 2018 to 2.7% and 30bps in 2019 to 2.4%. The committee now expects the unemployment rate to decline to 3.6% by 2019 – well below December estimates, which had unemployment bottoming at 3.9% this year before gradually rising. Interestingly, the FOMC revised up their projections for core PCE inflation in 2019 and 2020 to 2.1% – above their target of 2.0%. While this is a small change in the forecast, it is unusual for the Fed to forecast above-target inflation, especially several years into the future. This aligns with recent rhetoric by Fed Governor Brainard and New York Fed President Dudley arguing that the inflation target is symmetric and a temporary overshoot in inflation may be beneficial for reestablishing the underlying inflation trend. Overall, the outcome of this meeting was relatively neutral.
Despite the steeper Fed dots, forecasts three hikes this year and two in 2019, bringing the tightening cycle to an end at 2.625%. That would make sense given the global economy’s remaining headwinds (the threat of trade wars among the most prominent). While rate normalization would give policy makers room to manage any forthcoming crises, they’re likely to carefully weigh the extent of policy tightening against financial conditions and inflationary pressures.
As we expected, the 2018 median “dot” stayed put indicating three rate hikes in 2018, but median dots for 2019, 2020 and the “long run” moved higher. This confirms our core view on Fed policy: rate hikes will remain gradual in 2018, but significant fiscal stimulus implies a hike cycle that is more likely to continue through 2019. The number of 25bp hikes in 2019 implied by median dots increased from 2.25 to 3 and in 2020 from 1.5 to 2. The “long run” median moved up from 2.75 to 2.875%. While the 2018 median was unchanged, three dots moved up from 3 to 4 hikes (our best guess is Powell, Quarles and either Dudley or Williams moved higher). In the press conference, Chair Powell was slightly more dovish than the hawkish read on his recent Congressional testimony. Most notably dovish, Powell stated that there is “no sense in the data” that prices are about to accelerate. This reinforces that the pace of hikes in 2018 (even between three or four) remains tightly linked to the path of inflation over the year.
The updated “dot plot” boosts Fed funds forecasts moderately for the next few years. The biggest change in the median rate is 19 bps for 2019. The FOMC forecasts suggest another 12 bps in 2020, putting the total increase at 31 bps through that year. Our overall takeaway is the tightening cycle may extend a bit but the pace should remain slow. In light of the static dots and Chair Powell’s calm comments, we look for Treasury and U.S. swap 2s/10s to steepen in the near term. The FOMC appears to tread the same path under Jay Powell as under Janet Yellen: slower than usual tightening while waiting for fundamentals to improve further. We expect Treasury 2s/10s to steepen another 5 bps in the next week or so. We will be surprised if 2s/10s steepens 10 bps. Even a 10-bp move would be small relative to the 25 bps flattening that has transpired since early February. Moving out the curve, we continue to think 10s/30s will steepen, perhaps nearing 40 bps by year-end. The long-end steepener should be propelled by a gradual Fed as well as a big jump in Treasury supply. The cautious FOMC should support TIPS. The Fed seems prepared to wait for a material pickup in inflation before removing the proverbial punch bowl. We look for breakevens to rise across the curve, until at least the next CPI release in April.