Tuesday, June 13, 2017

FOMC Report June 13-14, 2017; Less Orderly Though Possibly Still Quarterly (…rate hikes)



The Federal Reserve is expected to raise the fed funds policy rate by 25 basis points and leave its guidance largely unchanged in the statement following their meeting this week.  That message has consistently expressed an interest in returning the policy rate to a more ‘normal’ level or more generally to reduce the overall level of monetary policy accommodation.  Despite less favorable general economic growth conditions during the first quarter, the Fed has conditioned market participants for an additional modest reduction in the level of accommodation provided. 

Some Fed officials are likely to voice concerns ( Minneapolis Fed President Kaskhkari a possible dissent) about continuing the removal of policy accommodation at a time when there is uncertainty about the potential for a lasting nature of the economic weakness and lower inflation prints seen earlier this year.  Clearly however, there has been a pattern of weaker economic growth in the first quarter followed by stronger growth toward the last three quarters (see ‘FOMC Report May 2-3, 2017; Still Quarterly and Orderly’).  This historic pattern alone is not reason enough to expect the Fed to lock into a policy path of quarterly 25 basis point rate hikes.  However, job growth continues to be strong and household incomes and wealth conditions are improving while global economic conditions are in repair.


This leaves room for my earlier forecast of ‘Quarterly and Orderly’ policy rate hikes this year to remain on the table, though less likely.  Economic growth will need to improve in order for the Fed to hike rates by 1% this year and there is little room for more than a modest geopolitical distraction.  Otherwise, the Fed is expected at this meeting to concentrate on where it stands now despite uneven growth and inflation paths rather than on exaggerated emphasis on what developments might be forthcoming. 

While the Summary of Economic Projections (SEP) will be parsed in order to extract a greater meaning than is truly available, we expect the 2017 year-end PCE inflation, GDP and unemployment projections to all be lowered by 0.1%.  We look with interest to see if the longer run unemployment rate expectations are lowered, though we think not at this stage.  Should the Fed leave the longer run unemployment rate forecast at current levels, this could provide some assurances that it is believed much of the slack has already been removed from employment condition.  This would mean too that the impact from strong labor market conditions on financial conditions is likely to overwhelm the recent and largely believed ‘transitory’ weakness in inflation.    

It is difficult to say why wage pressure has not been greater to date and even harder to know at what pace wage pressure may emerge in the face of continued outsized job gains.  A sense of stable wages conditions has been engrained because of weak productivity growth which followed higher levels of unemployment earlier.  While productivity for now remains at low historic levels, the psychology of employees and employers as concerns appropriate wage gains may change more rapidly with any further labor gains.  Productivity gains are not entirely necessary for this development. 

Finally, although there was some talk at the May FOMC meeting of a scale back in the measure of reinvestment of the Fed’s balance sheet beginning as early as this year, I still anticipate the actual run off of the balance sheet will not start until 2018, with an announcement in December.  As such, I do not expect a detailed announcement of this latest ‘tapering’ plan released at this meeting.  Instead, further details excluding the specific timing are likely forthcoming at a meeting between the July and the December meeting.    

Tuesday, May 02, 2017

FOMC Report May 2-3, 2017; Still Quarterly and Orderly



Economic growth in the first quarter was underwhelming as it has been in the first quarter for a number of years (Figure 1).   Stronger economic performance over the last few months might have made the Federal Reserve’s job of communicating its intention of moving forward with the removal of monetary policy accommodation easier.  However, we do not expect the Federal Reserve to be sidetracked in their intention to raise policy rates at a gradual pace.

There is no policy action expected at this FOMC meeting.  Instead, the Fed should be expected to indicate that economic performance is improving, that any slack remaining in the jobs market is being removed and that inflation is projected to reach its 2% target in the medium term.  Otherwise, the statement from this meeting is going to be like the bread served at a buffet dinner, intended to fill you up without providing much substance. 

Going back to 2009, the average first quarter Real GDP growth rate was less than 0.3%, far below the 1.8% overall average during that time span.  Even if we remove the extraordinary -5.4% first quarter 2009 contraction from our series, the first quarter average is still only 1%, less than half the overall period average.  Since 2009, the only quarters showing negative growth have been first quarter results.  At any rate, while the Fed will certainly take into account this year’s weaker first quarter data, they are unlikely to reformulate their policy path projection from what I have termed ‘Quarterly and Orderly’.  

The minutes from the March FOMC meeting gave considerable attention to the balance sheet and discussions about its reduction.  This of course attracted a lot of attention and rightly so.  We believing that Chair Yellen will want to at least have begun the process of removing the reinvestment of maturing securities held before her term ends early in 2018.  Some, including Scott Minerd of Guggenheim on Friday at the Milken Institute Global Conference, suggest the Fed might initiate a policy change therein as soon as September. 

My expectation is that the Fed will wait until December to outline a gradual and defined process of removing reinvestments which will begin in January 2018.  Waiting until December of this year appears more plausible, especially given the, once again, weak first quarter economic performance.  This timing would be consistent with the approach taken at the December 2013[1] FOMC meeting when the Fed announced it would begin to scale back the amount of securities purchases (taper) in a ‘path-dependent’ format that would be concluded by October of 2104.  We were delighted then in predicting the Fed’s course of action (FOMC Report December 17-18, 2013) when few saw similarly. 


A policy rate path that includes quarterly (March, June, September and December) 25 basis point advances in the target range will move Fed Funds to 1.5-1.75% in December, roughly halfway to its stated ‘Longer run’ projection of 3%.   Beginning a balance sheet adjustment when Fed Funds target rate is 1.5-1.75% would be consistent with the Fed’s long stated intention of waiting ‘until normalization of the level of the federal funds rate is well under way’.