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Preview of the March FOMC Meeting: Toward Another Kind of Liftoff

March 19, 2018

The March FOMC meeting marks the real start of the Powell Fed, and fittingly, it will be closely watched mostly for what it suggests about the outlook. Still, this is a big step not only because it is the first hike of the Powell Fed, but also because it brings the Fed’s policy rate into the gray zone between normalization and tightening. Much was justifiably made of the Fed’s first rate hike since the financial crisis, and of the tapering of asset purchases and then reinvestments; this step is far less clear-cut, but it’s still significant.

What’s at Stake:

  • Confirmation of the nearly universal expectation for a rate hike to a range of 1.50% to 1.75%.
  • The rate outlook: right now the hot debate is whether 2018 will be a year of 3 hikes or 4, but the entire dot plot and the yield curve’s response will be in sharp focus.
  • Insight into Powell’s decision-making process, via the press conference.

Rate Hike:

  • There has been no serious push back by policy makers against growing market expectations for another hike.
  • While consumer spending and some manufacturing data have been weak, inflation data have turned up (looking past monthly volatility) and job gains have been more than strong enough to push the Fed to take action.
  • Bringing the Fed’s policy rate into the gray zone between normalization and tightening is appropriate at this stage.
  • Although the relationship between inflation and a strong labor market has been called into question, the Fed cannot afford to ignore the strength of the labor market. That seems wise enough on purely economic grounds, but it’s especially true politically.
  • The equilibrium level for the Fed’s policy rate is believed to be around zero right now, and the Fed’s preferred measure of core inflation is running at just 1.5%, but it is expected to rise to or near 2.0% later this year.

Dot Plot:

  • The median 2018 year-end dots should shift upward, and they may well lift the median dot up to 4, but I would give the slight edge to the median remaining at 3. The Committee prefers optionality and wants to stress continuity with the Yellen Fed. There will be plenty of time to raise expectations at the June or September FOMC, if warranted. We know from Feb-March 2016 that it’s not too hard for the Committee to whip the market into shape if it wants to accelerate by a hike, and they don’t want to risk anyone thinking that Powell is bringing a regime change.
  • The 2019 dots should shift upward as well, likely leading the median dot to rise by one hike.
  • The 2020 and long-run dots are likely to shift upward as well, but not their medians. By 2020, fiscal stimulus will be fading and the Fed’s hikes will be biting.
  • It’s possible that the long-term rate will rise over time, if recent fiscal measures lead to productivity enahancements, but the Fed is likely to take a “wait and see” approach, especially given policy makers’ relatively reserved comments on recent fiscal measures’ long-term impact.

Economic Forecasts:

  • GDP forecasts: 2018 and 2019 forecasts will rise by a few tenths of a percent, in light of the tax law and spending bill, but not 2020 or the long run. The Fed’s line on recent trade headlines will echo their late-2017 refrain on tax changes: we will wait and see what comes to pass, rather than base our forecasts on speculations that are vulnerable to political vicissitudes.
  • Unemployment rate: 2018 and 2019 forecasts lower by a tenth of a percent or two. The long-run estimate could drift down as well, given some recent mild surprises in household employment gains and labor force participation.
  • Inflation: unchanged. Polciy makers are rightly confused and concerned about the relationship between inflation and either the labor market or growth overall. And while rising tariffs bring upside risk to inflation, the reality is that recent data prints have evolved more or less as the Committee predicted: the “reverse hot hand” of 2017 inflation is reversing, and it will take a few more months for trends to become clearer and crucial anomalies to drop out of the 12-month averages.

The FOMC Statement:

  • The statement’s language will mostly be unchanged, after the language on the outlook already got upgraded in January, although the labor market language may be further upgraded.
  • The language to keep an eye on is the “balance of risks.” Given the cloud hanging over inflation, the Committee is probably not ready to change this phrase yet, but this is something to watch in 2018. The Yellen Fed showed a disinclination to muck around with any “sacred cow” phrases in the statement. Instead, it worked around them, moving in other phrases that effectively shifted the weight off the phrase in question so that the original one could be safely removed. Keep an eye out for such shifts this year.

The Press Conference:

  • Chair Powell has shown he’s willing to disentangle his own views from those of the Committee, and his first press conference will be a prime opportunity to reinforce this and set the tone for his tenure.
  • Nevertheless, the order of the day will be a don’t-rock-the-boat approach, with Powell most likely signaling a noncommittal openness to a 4th hike and little or no opinion on trade issues
  • What, if anything, will Powell signal about his “reaction function” — how he will determine how many hikes to push for? If “balance of risks” is worth watching in the statement, “data dependence” is worth listening for at the presser.
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