The December Fed meeting will be a funny combination of momentous and moot. On the one hand, a rate hike is all but assured and the impending leadership transitions lower the information value of the Federal Open Market Committee’s projections. On the other hand, the rate hike is expected to move the policy rate to a pivotal level – roughly neutral given the current level of inflation – and markets will be hungry for any indication they can get about how the FOMC might respond to the tax bill expected to be enacted before New Year’s. The FOMC statement is unlikely to feature major surprises, but the economic projections and dot plot will be closely watched even if they don’t deliver big changes.
What's at Stake:
- A widely-expected rate hike, bringing the fed funds target range to 1.25-1.50%.
- The rate outlook: market attention has already turned to post-2017 rate hikes.
- Routine adjustments to the economic projections, official statement, and caps on balance sheet shrinkage.
- A rate hike is all but assured by the November jobs report and other recent economic data. The market is about as well prepared for this as it was for the balance sheet announcement at the September meeting, and it has already turned its attention to what comes next.
- This will be the second-most important non-event of the year, after the balance-sheet announcement. Current market-implied probabilities of a hike are running at around 90%.
- This rate hike will move the policy rate to a pivotal level – to roughly neutral given the current level of inflation – and the 2018 hikes will therefore be the start of outright tightening. Up until now, the Fed’s challenge has been to withdraw its extraordinary crisis-fighting measures and normalize its policy stance.
The Dot Plot
- Given the imminent turnover in leadership, the dots from this FOMC meeting will be less informative than usual about the outlook. Still, this is the best information we can get at this point, and market participants are sure to be closely attuned.
- The 2018 dots will be in particular focus, but they’re unlikely to shift much. The distribution of dots may shift upward somewhat in light of the expected tax-related fiscal stimulus, but the median dot will probably continue to predict 3 hikes next years. The Committee has shown little or no appetite for front-running the final form of the tax bill and the minutes of the November meeting suggest they have begun to get spooked by the persistence of downside surprises to the inflation reports.
- Given the many uncertainties, the 2019 and 2020 dots may not tighten up much. The flattening yield curve suggests that the market believes that rate hikes will slow in 2019, but the Committee may reaffirm 2.5 or more hikes, especially in light of the probable tax-related stimulus. If so, that will recall prior years when the dot plot has come in more hawkish than market expectations.
The Economic Forecasts:
- There will be only modest adjustments to the projections for rates and economic variables, to align them with recent economic data and the increased likelihood that the tax bill will be enacted and provide some short-term economic stimulus.
- The changes will be concentrated in the forecasts for GDP and unemployment, which will both be upgraded for 2018. The GDP projections should get raised 0.1-0.2% for 2017 and 2018, and perhaps 2019 too, but not 2020. The corresponding unemployment rate projections should drop by a similar amount, given the faster-than-expected drop this year.
- Projected PCE and core PCE inflation: no change. The data finally seem to be supporting the FOMC’s thesis that the streak of weak inflation reports this year was due to transitory factors, so now is not the time to abandon that view.
The FOMC Statement:
- There will be some modest updating of the official statement to reflect the latest economic data. The statement will likely note that business fixed investment has moderated, hurricane-related volatility is passing, and that overall economic growth has remained above trend.
The press conference:
- Questions about the flattening of the yield curve will be front of mind, including: what is keeping long rates so low, how the Committee views financial conditions, and how good a predictor of recession or financial instability is a flat yield curve.
- The implications of the tax bill will be another hot topic, but Chair Yellen won’t get drawn out on this point. Given the vicissitudes of every major piece of legislation down to the last minute before passage, it will be easy for Chair Yellen to continue to argue that she and the Committee need to see the final legislation before they comment on it with any detail, although she may admit that the strong likelihood of passage influenced the Committee's projections.
- There may be a few questions looking for the Chair to reflect on her tenure, but she will be as circumspect as ever, seeking to avoid front-running her successor, Jay Powell.