Focus on the dot plot. At next week’s FOMC meeting, attention will be focused on the dot plot – specifically, the outlook for rates in 2H 2017. The Fed has worked assiduously to ensure it intentions for this meeting are well understood by the market, so no one will be surprised to see:
i. Another rate hike,
ii. No action on the Fed’s balance sheet policy,
iii. Little to no information on plans for the balance sheet — that’s more likely to wait until the minutes of the June meeting, ahead of announcing more official plans later this year.
In the dot plot, the dispersion of the dots for year-end interest-rate levels may increase, reversing some of the convergence that occurred between the December and March meetings. A few dots may drift downward for 2017, but the medians will remain the same. Flagging expectations for expansionary fiscal policy and concerns about the debt ceiling debate will be mostly offset by confidence that growth is rebounding after the 1st quarter and further tightening in the labor market. Despite what some other commentators have said, the May jobs report actual supports the case for a June hike, and strength in the labor market, combined with a rebound in consumer spending, will continue to drive the Fed’s views on the near-term outlook, rather than recent softness in vehicle sales, housing data, or even consumer credit. Also, the Fed will remain eager to move forward with its program to normalize its balance sheet; they won’t give that up without a fight.
Summary of Economic Projections: The year-end projections for inflation and the unemployment rate should be revised downward modestly in light of the latest data releases, but for inflation, the post-2017 numbers won’t budge. The year-end unemployment rates will have to come down to 4.3%, but with job growth apparently moderating, it can stay there. Less certain is whether the Fed will see fit to adjust its longer-run estimate of the unemployment rate. If they don’t, the unemployment rate will look even more unsustainably low than it already does, which would embolden the hawks and underline the gap between current policy and the prescriptions of quantitative policy rules. With rumors already swirling about policy rules and future Fed nominations, current policy makers would prefer to avoid the appearance of letting the labor market run too hot, so a slight decline to 4.5% or 4.6% seems likely.
Revisions to the FOMC statement itself will acknowledge that:
o job growth appears to have moderated but remains healthy,
o household spending has rebounded,
o business fixed income softened,
o inflation has softened but is expected to rebound and still return to target over time.
o In contrast, the language on inflation expectations and the balance of risks will be left unchanged.
The Press conference will likely feature questions on the following topics:
o Debt ceiling / government shutdown: What does the Fed think about the potential for market volatility around this debate, whether or not it comes down to the wire? Would it delay another rate hike or action on the Fed’s balance sheet? Chair Yellen won’t give anything away here; she will zealously guard optionality for the Fed, noting that, as with the Trump administration’s prospective economic policies back in December 2016, the outlook remains too uncertain for the Committee to plan around it until material information becomes available. The reality is that the market could force the Fed’s hand here, so it all depends on how nervous the markets get.
o Conflict between employment and inflation data. With inflation softening and the latest data on earnings and income suggesting a flattening out in wage growth (rather than the expected acceleration), there are bound to be questions about whether the Fed should delay its planned hikes.
§ Chair Yellen will continue to dismiss the soft patch in inflation as “transitory” and assert dogged attentiveness to the risks of wage inflation emanating from labor market tightness. More specifically, she will stick to the party line that the Phillips Curve remains an important frame of reference, even if the economic environment has changed. She will note that with so few signs of slack left and given the lags in monetary policy, risk management dictates the Fed keep moving. (As noted above, Taylor policy rules currently suggest the Fed is behind the curve).
§ If secular stagnation and related debates come up, Yellen will try to remain agnostic here as well and focus on the risk management perspective, rather than commit to any positions in unsettled debates.
§ Potential asset price inflation and the Fed’s financial stability mandate may come up, but Yellen will be reluctant to address asset prices beyond emphasizing risk management.
o Recent recession risk and the recent flattening of the yield curve. If these issues come up, Yellen will note that there are many other factors aside from the Fed influencing the long end of the curve. The Fed needs to focus on its actual policy variables (unemployment and inflation) and where it has the most influence (the short end of the curve). As for recession risk, Yellen will revert to the upbeat assessment of recent data and the outlook and note that the yield curve is just one among many valuable indicators that the Fed monitors.
o Fed nomination rumors. Recent press reports of the Trump administration’s expected nominations for Chair and Vice Chair of the Fed will elicit questions about the issues and approaches these individuals are likely to take. Yellen will strive to steer clear here as well, except to defend the Dodd-Frank financial regulation reforms and the principles she herself has found appropriate and useful in her tenure at the Fed, rather than commenting directly on others’ ideas and how they differ. Nor will Yellen be drawn out on her intentions to stay on at the Board if a new Chair is appointed. This is a woman who was prepared to decamp to California rather than campaign for the top job, so we know she’s not interested in playing politics.
As iCIMS’ former chief economist, Josh Wright led a team of data scientists in analyzing emerging trends in the U.S. labor market. With publications ranging from academic journals to national media, Wright previously served as a U.S. economist with Bloomberg L.P., and was a staff researcher at the Federal Reserve.