This should be painfully obvious to anyone who’s been paying attention, but on the off chance it’s not, we wanted to quickly reiterate it ahead of the Fed: Jerome Powell is damned if he does and damned if doesn’t on Wednesday.
Over the weekend, in their Fed preview, Goldman wrote the following about the SEP:
The SEP might well be the most dovish aspect of the meeting, and we expect a three tenths cumulative downgrade to the median GDP growth projections, a one tenth downward revision to the median NAIRU estimate, and dovish revisions to the dot plot that drop a hike from the 2019 baseline (such a change would require two additional participants projecting that pace or slower). In terms of the number of hikes in 2019, 2020, and 2021, we expect a median policy path of 2-1-0, down from 3-1-0 as of the September SEP. If so, the projected overshoot (vs. r*) would decline to just half a hike in 2020 and 2021.
There are two key takeaways there and they are inextricably bound up with one another.
It is (virtually) impossible for the Fed to deliver an unequivocal “dovish surprise” via the dot plot. Why is that all but impossible? Simple: Because the market is pricing in just 10bps of tightening for all of 2019.
“Remember, even a capitulatory move from the Fed to lower the 2019 dots towards 2 still remains massively above the Eurodollar calendar spread implied pricing at just ~10bps”, Nomura’s Charlie McElligott wrote Tuesday. Here is the chart (bottom pane shows the market pricing in easing in 2020).
Again, there is zero chance that the dot plot, however it ends up looking, is going to be consistent with what the market is pricing for next year.
Given that, the Fed will have to lean on tweaks to the statement and, as indicated in the above assessment from Goldman, the growth outlook, to convey dovishness.
But that’s a trap. Market participants are already hyper-sensitive to bad news about growth, as evidenced by all the hand-wringing about the nascent inversions in the curve. On a global scale, BofAML’s most recent fund manager survey showed respondents are the most worried they’ve been about global growth since October 2008.
Just about the last thing the Fed wants to do in that scenario is effectively echo those worries, as that would risk undermining sentiment further. But the only way to communicate a dovish “enough” outlook on Wednesday is through the growth projections because, again, there’s no chance of delivering a dovish surprise via the dots.
“It would take a massive growth assessment downgrade from the Fed to capitulate down to the market’s expectation levels [but] a growth downgrade of that extent could in fact confirm the market’s ‘worst fears’ of [a] growth slowdown and further the risk-sentiment death-spiral,” the above-mentioned McElligott goes on to warn.
Not helping matters is FedEx’s after hours guidance cut, which found the company guiding below the lowest estimate for 2019. “Global trade has slowed in recent months and leading indicators point to ongoing deceleration in global trade near-term,” CFO Alan Graf said in the statement, adding that the company “remain[s] committed to actively managing costs with a heightened focus on increasing efficiency across the organization.” The shares plunged.
One more time: the last thing Powell wants to do is exacerbate growth concerns by trying “too” hard to deliver on a dovish message via aggressive downgrades to the growth projections. And indeed, it’s not even clear aggressive downgrades are necessary in the first place, which complicates this even further.
“With overall activity data staying more or less solid, we do not see much scope for substantial downward revisions to the median economic projections”, BNP writes in their own Fed preview, adding that nevertheless, they do “expect the median growth projections to be revised down for 2019, by around 0.2-0.3pp, with weaker business fixed investment being a driver.”
Here’s Barclays’ take on the projections, for whatever it’s worth:
We do not think that members will reduce growth forecasts for 2018 much in light of recent data that point to strong retail sales and, in turn, growth in private consumption. That said, a weaker external outlook and tighter financial conditions will likely lead staff to revise lower its outlook for growth in 2019 and we think FOMC participants will feel the same. As a result, we see 2019 growth as likely to be revised lower to 2.4% from 2.5%, or what the median committee member expected in June. In addition, we expect members to revise lower their outlook for both headline and core inflation to reflect underperformance in core and the decline in energy prices. Finally, unemployment has largely proceeded in line with member forecasts and we expect that path to remain unchanged.
For their part, BofAML expects “downward revisions to headline and core personal consumption expenditures inflation projections for this year reflecting the decline in energy prices and the relatively weaker string of core PCE inflation prints of late” and the bank also thinks “the growth and headline inflation forecast for 2019 are likely to be revised modestly lower.”
Long story short, this is going to be a very, very delicate task. The dots will shift lower, but not “enough” to placate market participants who have aggressively priced out the rate path, so the growth outlook needs to be revised down to make up for whatever dovish deficit (if you will) there is between the new dots and market pricing. But the growth projections can’t be too dramatic, because that risks undercutting sentiment further at a tenuous juncture.
On the statement, it’s also a tightrope walk. They want to convey data dependence and tweak the language around “gradual” but they want to avoid casting the incoming data in too dour a light, so as not to spook anybody. Here’s one more quote from McElligott:
Powell will need to ‘thread the needle’ by messaging that even IF the Fed were to move away from their current “regular and predictable” (quarterly) hike schedule, that this is not an indication that we have reached the end of the policy normalization cycle—which is delicate, because a market set on a dovish expectation could over-interpret this as hawkish.
And then there’s the presser which is a complete crapshoot at this point because, after all, Powell’s “plain English” turned into a “plain disaster” when it accidentally translated into “long way from neutral” in October. So, very much unlike earlier this year, he will no longer be given the benefit of the doubt when it comes to communication.
Finally, he (Powell) has everyone from Druck to Warsh to retail investors to the President of the United States breathing down his neck.
As Trump ominously put it on Tuesday: “Good luck!”
Read more from our Fed preview