I’m not sure I would want to be Jerome Powell right now.
The Fed is staring down a veritable laundry list of embedded contingencies as the committee ponders the appropriate course of monetary policy in an environment where the incoming economic data arguably supports a continuation of gradual rate hikes against a backdrop where the geopolitical risks are piling up and domestic politics is laughably fraught.
The President wants easier policy to help fight the trade war, but that same trade war raises the specter of tariff-related price pressures. At the same time, trade frictions are clouding the outlook for global growth. Eventually, one assumes, a deceleration in the global economy would boomerang back stateside, especially once the effects of late-cycle stimulus begin to wane.
Folks are looking for a potential removal of the word “accommodative” from the statement, in a nod to the notion that policy is closer to neutral. Jerome Powell will doubtlessly face questions on Wednesday about the trade war and the potential for spillover from international developments to U.S. markets. As far as the dots go, it’s a matter of cementing a December hike in the minds of market participants who have recently demonstrated a willingness to “believe” the Fed.
Let’s run through the charts (all via Bloomberg) and then we’ll get to the analyst commentary and the decision.
First of all, wage growth is accelerating at its swiftest pace since 2009:
The latest CPI data show inflation decelerating slightly in August both on headline (top) and core (bottom):
PCE is at 2%:
All of that would appear to argue for an upbeat assessment and a “stick your guns” approach to hikes. That’s underscored by still positive data from the labor market and ebullient sentiment data, although there’s a growing divergence between “soft” and “hard”:
Markets are increasingly catching up to the dots and expectations for “more cowbell” (if you will) in March are steady:
The recent pullback notwithstanding, expectations for hawkish monetary policy have driven the dollar inexorably higher since April:
Spec positioning reflects that bullish sentiment:
This isn’t something Donald Trump is particularly enamored with. The stronger the dollar, the less effective the tariffs and the President’s calls for looser monetary policy have become more shrill since July (full “Trump vs. Powell” archive here).
Trump waits on Fed….. pic.twitter.com/5rh0lqNtP4
— Walter White (@heisenbergrpt) September 26, 2018
The curve continues to close in on inversion, the recent steepening episode notwithstanding:
10Y yields are near YTD highs:
The spec short in the 10Y is sitting near a record:
As alluded to above, all of this playing out amid a severe downturn in ex-U.S. assets, especially emerging market equities, debt and FX. Any further hawkish turn from the Fed could exacerbate that.
Here are some excerpts from Wall Street which, when taken together, should give you a decent idea about how everyone was feeling headed into Wednesday’s decision. These are for context and should help folks parse the dots, SEP, statement and presser.
Dec is already a “done deal” in the market’s eyes, with March ’19 the “chalk” as well (59% probability right now)—although the market is still only pricing TWO hikes in ’19;
Post March ’19 Fed, we could see a “pause” thereafter to digest the approach of the (as it currently-stands) neutral rate or a push beyond into “restrictive” policy territory, as dictated by the pace of the economy
As we expect the long-term dots to move towards 3% (somewhat technical via Clarida’s dot addition, bumping the median dot higher as a result), it would make sense for the new 2021 dots to be the same as the 2020 forecast
Not today’s business: We believe the potential (hawkish) removal of “remains accommodative” language to be a story for the December meeting, while too we do not expect any tweaks to IOER rate (more likely a Dec event if at all)
Inflation is at target, the unemployment rate is below target and falling, and yet the funds rate remains 100bp below the Fed’s estimate of its neutral level. Most FOMC participants now agree that this makes little sense—the Fed has some catching up to do. A rate hike is widely expected at the September FOMC meeting, and barring a significant shock the path up to neutral seems likely to prove fairly uncontroversial as well.
We do not expect any substantive changes to the FOMC statement, with the description of the policy stance as “accommodative” a touch more likely than not to remain. While the FOMC seems to have anticipated removing it in August, an increase in the Fed’s lowest r* estimate might have shifted the goalposts: even after the hike next week, the funds rate will remain below the entire range of r* estimates published by the Fed. In any case, we see the issue as fairly unimportant since the dots already reveal the Committee’s neutral rate estimates.
Changes to the economic projections should be minimal, with 2018 growth bumped up a bit. The median interest rate path is likely to remain unchanged, but we expect a firmer consensus around 4 hikes in 2018, 3 in 2019, and 1 in 2020. The new 2021 projections will offer insight into the Fed’s plan to manage the overshoot of its labor market target. We expect a flat terminal funds rate of 3.25-3.5% and a slight uptick in the unemployment rate as the restrictive policy stance does its work. Finally, we expect the median neutral rate dot to move up slightly to 3%, although this is uncertain and partly driven by changes in the composition of the committee.
The Fed has been signalling for some time that it is ready to take another step in withdrawing policy accommodation, and markets are expecting this outcome.
In the updated set of economic projections, we look for modest adjustments to growth, unemployment, and inflation in 2018 to reflect incoming data. Values for 2019 and 2020 should remain largely unchanged. On net, we view these adjustments as minor and they should not signal that members have shifted their view on the likely course for the economy. As a result, we do not expect any change in the median path for policy, even with the addition of Vice Chair Clarida’s forecast. We look for the median funds rates projection to remain unchanged at 2.4% in 2018, 3.1% in 2019, and 3.4% in 2020.
We expect projections for 2021 to signal that restrictive monetary policy will begin to reverse the modest overshooting of the dual mandate. If so, members are likely to project below-trend GDP growth to lift the unemployment rate toward NAIRU and to guide inflation back down to the target. Various versions of the Taylor rule would likely point to a funds rate that should begin to move lower towards neutral. As a result, we forecast a slight reduction in the median funds rate to 3.3% in 2021.
We expect the committee to state that monetary policy is “somewhat” accommodative. Chairman Powell has indicated that the Fed would not remove this language until the funds rate moves to within members’ estimates of its longer-run value. This is likely to be the case in December if, as we expect, the Fed lifts the funds rate for the fourth time this year. In our view, a modest tweak of the language to suggest that policy is closing in on a neutral stance is all that is warranted for now.
The focus will be on the FOMC’s forecasts, which will be extended to 2021. The dots will take center stage. There are a few moving parts. First, we will be gaining forecasts from Vice Chair Clarida, bringing the total number of submissions to 16. We believe that Clarida’s forecasts for this year and next will be close to the median. However, the risk is that he expects a more shallow long term path for rates as he has been on the record discussing the likelihood of a low long run R* (neutral rate). In addition, John Williams has moved to the NY Fed, leaving an opening at the head of the San Francisco Fed. Mary Daly has been named the new President but we do not expect her to make major changes to the submissions for this meeting. Our expectations for the dots: 2018: 4 hikes to 2.375% (no change); 2019: 3 hikes to 3.125% (risks to the downside as only 1 or 2 people need to shift); 2020: 1 hike to 3.375% (no change); 2021: “half of a hike” to 3.50% on the view that 2 of the centrists look for one additional hike in 2021 but the rest assume no change. ; Long run: edges up to 3.0% with Clarida coming in at 2.75% (or lower) but 1 other member moving into the 3.0% camp.
This would mark another step closer to neutral rates (somewhere between 2.25-3.50% for fed funds). The FOMC’s forecasts for 2018 look on track and warrant no changes. However, the recently implemented tariffs on an additional USD 200bn of goods imported from China are now on the books and could push some members to mark their 2019 and 2020 forecasts for GDP growth down and inflation up (probably in the neighborhood of subtracting around 0.1-0.2pp from GDP projections and adding a similar amount to inflation). We expect a discussion of the “downside risks” to growth and “upside risks” to inflation posed by these trade policy changes in both Chair Powell’s press conference and the subsequent minutes of the meeting. Undoubtedly, the Committee will have to walk a fine line so as not to end on the wrong side of a presidential tweet.
Trade policy will undoubtedly create greater market and economic uncertainty, which could result in a more nimble Fed – in line with our long-standing expectations for a pause in early 2019. Despite the uncertainty around trade, we expect the Fed to signal that if data continues on a similar track, “further gradual” increases in fed funds are likely. Moreover, we could get some hints in clarifying the Fed’s plans for its balance sheet policy – in terms of both the next steps that will be taken and current discussions on the FOMC table.
While the August Minutes showed “many” participants agreeing that it would likely be appropriate to remove the characterization that monetary policy “remains accommodative” from the statement at some point in the not-too-distant future, with fed funds anticipated to still be around 0.75pp below the FOMC’s median estimate of the longer run neutral rate, a move on this front in September may be a tad early, but possible. The FOMC could also take an interim step and describe policy as remaining “moderately accommodative”, for example
Here’s a last minute quip from Luke:
If the three Fed narrative scenarios going forward are:
a) pause around "neutral"
b) follow the last dot plot
c) signal an acceleration
Seems as though c) is getting zero love.
— Luke Kawa (@LJKawa) September 26, 2018
With that as your guide, here are the bullet point highlights, followed by some quick color/reactions, then the dots, the projections, and the statement.
- FED RAISES RATES, REMOVES REFERENCE TO `ACCOMMODATIVE’ POLICY
- FED MEDIAN ESTIMATE STILL SHOWS THREE RATE HIKES IN 2019
Median assessment of appropriate pace of policy:
- 2018 2.375% (range 2.125% to 2.375%); prior 2.375%
- 2019 3.125% (range 2.125% to 3.625%); prior 3.125%
- 2020 3.375% (range 2.125% to 3.875%); prior 3.375%
- 2021 3.375% (range 2.125% to 4.125%)
- Longer Run 3% (range 2.500% to 3.500%); prior 2.875%
The removal of “accommodative” from the statement will likely be seen as dovish. That said, a December hike is now pretty much a lock. The dots show 12 of 16 officials on the 4 hike page for this year. Thus, the discussion going forward will be about 2019 and, more to the point, about the possibility that policy becomes unduly restrictive.
The dollar snapped lower in what may well prove to be an overshoot and/or misinterpretation. Indeed, Powell noted in the presser that “overall, financial conditions remain accommodative.” He went on to emphasize that the removal of the word did not signal a change in policy.
The 2s10s briefly snapped tighter, but 5s30s steepened pretty notably:
“Markets had already heavily discounted the risk of a hawkish Fed outcome before the meeting,” Nomura’s George Goncalves said.
Here’s how that panned out:
Information received since the Federal Open Market Committee met in August indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.