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’.