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Investors Focus on Fed Economic, Inflation Forecasts After Rate Hike

Investors Focus on Fed Economic, Inflation Forecasts After Rate Hike
(Elena Duvernay/Dreamstime)

Wednesday, 13 June 2018 07:40 AM

Federal Reserve Chairman Jerome Powell has repeatedly played down the central bank’s “dot plot” as a guide to future interest rates, but Wall Street just won’t take the hint.

While the Federal Open Market Committee is almost certain to raise rates a quarter point at the close of a two-day meeting Wednesday, investors are focused on whether the panel will signal one or two additional 2018 hikes when it releases updated interest-rate forecasts with the policy decision at 2 p.m. Powell will begin his press conference 30 minutes later.

The FOMC was about evenly split in March when it projected three hikes this year, so just one participant switching to four hikes could shift the median of the committee. Accelerating growth and inflation rising to target might argue for a more aggressive tightening, while lackluster wage increases and fragile emerging markets would suggest caution, Bloomerberg explained.

“The market will be focused on 2018 dots,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “It is a close call. I’m leaning toward four but without much conviction. The FOMC is really focused on the language but I think that will be overshadowed by the dots.”

Powell advised investors in his March press conference not to focus too much on the dots. Asked about its projections for 2020, he said policy makers “don’t have the ability to see that far into the future.” That echoed his 2016 view when he pointed to “shortcomings” in the dot-plot.

Economists surveyed by Bloomberg predict the FOMC will stick with its March prediction of three hikes this year in the updated quarterly forecasts.

Even so, “there is a risk that the dots go up a tad, not down,” said Steven Ricchiuto, chief U.S. economist at Mizuho Securities. “All you need is for one to change. There has been enough strength in the economy” to tilt to more tightening.

The Summary of Economic Projections could see other changes that reflect mostly upbeat economic data since March. Forecasts could show higher 2018 growth, lower unemployment rates and possibly slightly higher inflation, said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC.

The committee will also debate the language in its policy statement. Minutes to the last two FOMC meetings showed officials have begun to discuss changes reflecting that policy is moving closer to neutral rather than still being characterized as “accommodative.”

“I’d expect this part of the statement to be softened to something like ‘somewhat accommodative’ or perhaps even dropped,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore and a former Fed economist.

In the press conference, journalists are likely to ask Powell about softening global growth and emerging markets struggling with higher U.S. rates. Currencies of such nations have been hammered in a spreading selloff amid worries that their economies won’t cope with higher U.S. borrowing costs.

“The tone of the press conference will be important,” and Powell will likely strike a balance, “not eager to raise faster or slower,” said Roberto Perli, a partner at Cornerstone Macro LLC in Washington.

While the Fed has plenty of topics to dissect -- from a falling unemployment rate to emerging-market pain.

Bloomberg explained that Powell and his colleagues could shed light on these five longer-run policy themes:

1. Hot in here?

The labor market is running hot, so a job market discussion is sure to be on the Fed’s agenda. The committee’s 2018 unemployment projection is probably destined for a revision, since it places joblessness at 3.8 percent by the end of the year and the data hit that level in May. But more interesting is whether officials will cut their longer-run unemployment estimate -- now at 4.5 percent -- and how they explain any change.

The Fed says unemployment is already running below the level that can be sustained in the longer run, but wages are crawling higher rather than taking off. What’s more, job growth hasn’t slowed down as much as you might expect in an economy with a big worker shortage.

Those developments could push the Fed to revise down that longer-run jobless rate, signaling the labor market is not as hot as expected with unemployment this low. More people working means the economy has more capacity to grow, and a change in the longer-run estimate could be a sign that the Fed thinks unemployment can sustain lower readings without sending inflation too high.

On the other hand, if the longer-run jobless estimate doesn’t come down, that would signal that the Fed sees an economy well on its way toward overheating. Translation: either more rate hikes or higher inflation could be in train.

2. Knocking on neutral?

Any details on the coming shift from easy to tight monetary policy will definitely draw attention.

Officials in March expected to cross that threshold in 2020, when their median estimate saw rates reaching 3.4 percent. That lies two quarter-point hikes above the 2.9 percent they estimate as the longer-run neutral level -- the one that will neither support nor slow growth. Powell acknowledged back in March that such a policy path would be modestly restrictive, but added that out-year estimates are “highly uncertain.”

Fed officials remain split. Governor Lael Brainard said in a May 31 speech that “it seems likely that the neutral rate could rise in the medium term above its longer-run value.” In short, the Fed could boost rates above long-run neutral without intentionally curbing growth. John Williams, the San Francisco Fed president, has made it clear that he’s OK with moving into actually tight territory. On the other side of the debate, presidents Robert Kaplan, Raphael Bostic and Patrick Harker have urged caution.

“If more Fed officials begin to bring on board the idea of a pause at neutral -- which is far from generally supported,” then “there might be some risk that the 2019 or 2020 dots actually drift lower,” TD Securities analysts wrote in their Fed preview.

3. Any guidance?

Forward guidance’s days are limited, according to Fed minutes and officials including Powell. As the Fed scraps the practice of pledging lower-for-longer rates, two statement sentences are in the cross-hairs. One says the “federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” and the other explains that “the stance of monetary policy remains accommodative.”

The immediate query is whether those phrases will be dropped in June, a sign that a decade of market hand-holding is coming to an end. Cutting the first sentence would also be “opening the door for policy to turn restrictive over time if warranted,” economists at Barclays wrote in a note previewing the meeting.

Forward guidance is also part of a broader question: how will Fed communication shape up under Powell? In March, he indicated that he’s still considering the possibility of a press conference at every meeting instead of the current quarterly approach, and that topic could come up again.

4. Pushing limits?

Fed balance sheet runoff is playing out in the background, as promised, but it has begun to sneak into the foreground.

The effective fed funds rate has been pushing toward the top of its range, which for years has been the level of interest on excess reserves, or IOER. As a result, the Fed has signaled that it is thinking about setting the IOER five basis points below the top of the target range.

Upward pressure on the effective funds rate could come from technical factors, but there’s a chance that it’s a sign bank reserves are becoming scarce. If Fed officials think that’s possible, it may prompt them to discuss how small the balance sheet should become over time and how they will manage the funds rate in the future.

“We believe nascent signs of reserve scarcity are contributing to the move,” Mark Cabana, a Bank of America rates strategist, wrote in a recent note. “The Fed is now near a crossroads for making a decision on its longer-run monetary policy framework.”

5. Emerging markets versus the Fed?

Fed officials have been unfailingly chill about global developments in recent months.

Powell dismissed the role of U.S. monetary policy on foreign financial conditions as “often exaggerated,” speaking in early May. Brainard mentioned emerging markets in her recent speech, but placed more emphasis on upside risks posed by U.S. fiscal stimulus.

“They’re more focused on the domestic economy,” said Kevin Cummins, an economist at Natwest Markets Securities Inc. in Stamford, Connecticut.

Yet as emerging markets suffer a rout, central bankers in India and Indonesia have called for Fed restraint. Against that backdrop, Powell is sure to field some globally-conscious questions. Any signs of nervousness could be a dovish signal.

Meanwhile, the Fed also reportedly may be close to deciding to have a news conference after all of its eight meetings each year.

The Wall Street Journal reported on its website Tuesday that Fed Chairman Jerome Powell is considering holding a press conference after every meeting and may make a decision soon.

The Fed had no comment on the report, the Associated Press reported.

At his first news conference in March, Powell said that expanding the number of news conferences was something he was “carefully considering.”

Former Fed Chairman Ben Bernanke began the practice of having four news conferences a year in 2011. Some Fed officials have expressed worries that this schedule has left markets believing the Fed will only change policy at meetings followed by a news conference.

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The Fed could up its economic and inflation forecasts, sounding more hawkish as a result.
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Wednesday, 13 June 2018 07:40 AM
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