If you define “success” as engineering a risk asset rally and pushing rates vol. to new historic lows, then the global dovish pivot from central banks has been successful.
Equities and credit come into the March Fed meeting having rallied mightily off the December panic lows and wides, respectively. The S&P is within shouting distance of the September highs (despite the fact that Q1 earnings season is expected to show shrinking corporate profits) and high yield spreads have come in more than 150bps.
Meanwhile, rates vol. hit fresh record lows this week as a renewed emphasis on dovish forward guidance appears to have reestablished predictability and “transparency” as the guiding principles of monetary policy.
On that, recall the following passage from a recent note by Deutsche Bank’s Aleksandar Kocic:
Despite years of accommodation, things don’t look great, but not very bad either. There does not appear to be any major economic imbalances or runaway inflation on the horizon that could trigger a dramatic economic downturn. Even if we are recession-bound, given stricter regulatory constraints and years of considerable deleveraging of the private sector, the recession is likely to be a shallow one without massive and/or very aggressive deleveraging. However, given the expansion of the public balance sheet and still relatively low rates, we are less prepared to combat recessions, even if they are shallow. This means that, in addition to rate cuts, the Fed would need to grow its balance sheet again, which takes us back to financial repression, low yields and range bound rates, which implies another wave of protracted supply of convexity to rates and transfer of uncertainty from rates to other markets. With that outlook, it is difficult to build a case for owning rates volatility over any horizon.
Incidentally, Kocic did make a qualified case for owning rates vol. about a week later, but that excerpted passage captures the essence of the current environment.
I suppose it’s at least possible that the YTD rally in risk assets and the concurrent loosening of financial conditions (see visuals below) could prompt the Fed to deliver something that approximates a slightly hawkish spin on things at the March meeting, but it’s hard to imagine how that could offset an expected shift lower in the dots and the possible announcement of an end date for balance sheet runoff.
Additionally, the FOMC has made it abundantly clear that they intend to cite subdued inflation as an excuse to maintain a “patient” approach (no matter how hot the labor market is running) seemingly cementing the dovish bias. And in any case, the disappointing February jobs report underscores the case for caution. Meanwhile, a cooler-than-expected CPI print seemingly offset the hotter-than-anticipated AHE number that accompanied payrolls, so any inclination towards hawkishness based on cycle-high wage growth was likely snuffed out before it could get any momentum at all.
Bottom line: the Fed has demonstrated a propensity to err on the side of letting inflation run hot in the interest of avoiding a scenario where the US turns into Europe which has turned into Japan.
“The main question for the March meeting is just how far Fed officials will take the new theme of patience and the new perspective on inflation in their next set of projections”, Goldman writes, in their FOMC preview.
In light of mixed data since the January meeting, Goldman expects the following changes to the statement in March:
As far as the SEP is concerned, Goldman is looking for a two-tenths cut to the 2019 growth forecast and a one-tenth downgrade to next year’s outlook. On the unemployment rate, the bank sees the committee revising the 2019 forecast up a tenth to 3.6% and revising the longer run rate lower to 4.3%. Notably, Goldman sees the dots tipping just one hike over the entire forecast horizon. To wit:
With much of the Fed’s dovish shift coming at the non-SEP January meeting, the dots have quite a bit of catching up to do. The December dots showed a median projection of 2 hikes in 2019, 1 hike in 2020, and no hikes in 2021, for a terminal funds rate of 3-3.25%. In March, we expect the median dot to show just one hike over the forecast horizon, most likely in 2020, for a terminal funds rate of 2.5-2.75%.
Barclays says the obsession with the “patient” narrative and the likely downgrades in the SEP will mean the median member “will project no hikes in 2019 and one 25bp rate hike in 2020.”
“That said, some FOMC members have said that they would be comfortable with additional rate hikes depending on the evolution of inflation and the outlook”, the bank adds, qualifying their take and noting that “the average policy path [is] likely to be skewed in the direction of more hikes than less.” Here are the bank’s projections for the SEP and the dots:
And here are the bank’s projected changes to the statement:
SocGen thinks the dots will tip one more hike in 2019 (although their own forecast is for no hikes). The bank’s Omair Sharif frames things as follows:
We expect that the number of rate hikes for 2019 will be trimmed from two to just one. Indeed, at this point, it seems like the Committee has split into at least two camps.
One camp, in which we would place the likes of Harker, Mester, Rosengren, Bostic, and Evans (based on their public comments), has indicated that another hike would be warranted later this year if the economy evolves as expected with growth around 2.0%-2.5%, inflation near target, and the unemployment rate a couple of tenths lower. The second camp, consisting of Kashkari, Bullard, Daly, Williams, and perhaps Kaplan, has stated that no further hikes are necessary if the economy evolves as expected. That still leaves George and Barkin, although we would place George in the first camp.
Regardless, note that the debate has shifted to whether even one hike is appropriate. That implies a sharp move lower in the 2019 dots. However, note that it would take seven individuals to shift down to the current funds rate of 2.375% for the median to signal no change in rates this year. That seems like a tall order. Instead, while several people currently in the one-hike camp could shift to zero, we expect most will shift from the two hike camp (currently at 5 individuals) or the three hike camp (currently at 6 people) to just one hike, so the median projection overall will decline from two hikes to one (it would only take three people shifting from two hikes to one hike to move the median down).
BNP echoes Goldman in noting that the dots do indeed have a whole lot of “catching up to do” following the January dovish pivot, but the bank still sees one hike being reflected in the median.
“While [the Fed’s stance] argues for a substantial downward adjustment in the implied rate path, in our view, it still suggests a slight bias towards hikes, which we think will remain reflected by one dot”, the bank wrote Friday. “We see the Committee removing two of the three remaining hikes in the projected path at its March meeting, leaving just one implied hike left in the path, in 2019.” That said, BNP’s own projection is for no more hikes in 2019.
As far as the balance sheet goes, folks are divided on exactly when an announcement on an end date for runoff will come (i.e., whether we’ll get that this week or not). If you ask Goldman, we will indeed get the official word at the March meeting. “We expect the Committee to announce that runoff will conclude at the end of Q3 or—based on Chair Powell’s speech last Friday—perhaps in Q4”, the bank writes, adding that “recent comments from Fed officials suggest that the size of the balance sheet will then likely be held constant in nominal terms for some period to further reduce reserves at a more gradual pace through the growth of non-reserve liabilities.”
For his part, the above-mentioned Omair Sharif expects an announcement, but reckons the details are still being hashed out behind the scenes. “In March, we expect that the Fed will announce that the balance sheet runoff will cease at year-end, but we suspect that the finer details of the plan will be announced at upcoming meetings”, he says, before noting the obvious, which is that irrespective of what is actually announced (or not announced), “any news about the balance sheet at the March meeting will undoubtedly garner the most attention.”
Barclays expects the Fed to go ahead and deliver most of the details – or at least that’s what it sounds like from the bank’s preview. To wit:
We expect the committee to announce its intention to end securities redemptions from its SOMA portfolio in June [and] based on our estimates, the level of excess reserves at the end of June will be in the neighborhood of $1.4trn. We see this as a natural time for the Fed to end its policy of letting maturing securities roll off its balance sheet. Thereafter, beginning in July, any maturing principal from the Fed’s holdings of Treasuries and MBS securities will be re-invested into Treasuries, keeping the size of the SOMA portfolio stable and the Fed’s holdings of MBS securities in decline.
Credit Suisse thinks everyone is going to have to wait until May. “We expect the Fed to announce plans to end balance sheet run-off at the May FOMC meeting, but we wouldn’t rule out an earlier announcement in March”, the bank wrote in a Thursday note, adding that the “balance sheet decline will most likely end in September or October, but a bad quarter-end turn on March 31st could bring the end date into the first half of the year.”
Just to kind of round this out, here is a handy table from BNP which shows the history of communication on the balance sheet and the bank’s forecasts for how things will evolve from here:
And look, we could go on. But you get the idea.
All eyes (and ears) will be trained on the balance sheet discussion and it’s possible that a “failure” to adequately address the issue (where “failure” at this point probably means demurring on an announcement of the end date for runoff and then not providing any meaningful clarity beyond what we got in January) could prompt some indigestion from markets.
Read more on the balance sheet and the “roadmap” for runoff
It’s also at least possible that “too much” talk about improving/loosening of financial conditions could go over poorly to the extent anyone gets the idea that any further rally in equities might prompt the committee to start thinking about squeezing in another hike, even as the balance sheet runoff comes to an end.
Ultimately, though, it seems more likely than not that the March meeting will underscore the “patient” narrative and could well reinforce the steady grind lower in rates vol. Whether or not Powell can come across as dovish “enough” to trigger another leg higher in stocks without accidentally “confirming” fears about the outlook for growth is another question entirely.
Oh, and don’t forget that the US is now a country where the executive bullies the central bank at party rallies…