“Less Room To Run” – What Wall Street Is Paying Attention To In Today's Fed Statement
When it comes to today’s FOMC decision, there is little speculation: a 25 bps rate hike, the first in 2016 and only the second since the financial crisis, is now effectively assured: all 103 Bloomberg-surveyed economists expect a 25bp increase. The market agrees, and as shown in the chart below, implied rate hike odds are at 100%, with some even speculating that the Fed may hike by 50 bps.
Thus, as has been the case throughout the year, less emphasis is to be placed on the rate decision itself given the current expectations (despite them being for a hike), although this could be an entire reversal if the FOMC were to leave rates unchanged. Furthermore, participants expected the FOMC to wait until December, given that there will be accompanying Dot Plot projections and the chance for the Chair to explain herself and the decision in greater detail.
In recent months, the data releases have been solid and improving (despite a modest wobble over the past week) as we head towards the end of the year, and many of the Fed members have expressed the continuation of this improvement is likely to result in the hiking of rates towards the end of the year. The latest jobs report saw a marginal beat on the expected reading while unemployment dropped drastically to 4.6% vs. Exp. 4.9% (Holiday Season) while the PCE inflation metrics, core and headline, have continued to improve, which has always been on the Fed’s radar. The most notable commentary from members includes: Bullard stating that a December hike looks reasonable, Mester commenting that another rate increase is a prudent step to take while Powell commented that the case for a hike has clearly strengthened.
It’s also worth mentioning that no FOMC voter has attempted to pour cold-water on a Dec hike, however, Chair Yellen has produced a decidedly non-committal tone despite market expectations stating that their appeared to be scope for additional labour market gains yet leaving rates on hold could lead to excess risk taking.
As we approach 2017, further factors begin to take hold, most notably the alteration of the voting members of the Fed. This year will see Kaplan, Kashkari, Harker and Evans take up voting positions while George, Mester, Bullard and Rosengren are to resume their non-voting duties. Many have stated that this could offer a more dovish tilt to the composition of the board which in turn may influence some of the more crucial meetings next year. Analysts at Barclays have stated that they expect two hikes next year which will be packed into the end of the year (September and December), while forecasting a low risk of a faster pace of hikes in 2017. They have also highlighted that even though higher interest rates and an appreciated USD have tightened conditions to a degree, they remain accommodative.
Finally, this decision comes in the wake of the post-election rally and the anticipation of a Trump Whitehouse. The fiscal easing his team has proposed is viewed both as stimulatory and inflationary, as seen in the move higher in both stocks and yields over the last few weeks.
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So with December in the bag, two questions emerge as key, the first of which is what will the Fed hint about 2017.
According to Wall Street consensus, the FOMC is unlikely to alter its forecast for two rate hikes in 2017 in today’s decision and probably won’t adjust longer-term dots by much as it’s too soon to judge economic impact of Trump administration policies. So with rising expectations for growth and inflation, as well as tightening U.S. labor market, the Fed should have all the confidence it needs to hike for first time this year with no abstensions expected; that said, the cautious is Fed seen by some as looking to avoid rattling markets, and will likely wait for details on Trump’s plans. Looking at the future, BNP, JPMorgan, Morgan Stanley are among those expecting Fed to keep 2017-2018 dots the same or little changed.
According to Goldman, which has been a noted USD bull for the past year, monetary policy normalization in the US has the potential to drive the Dollar much stronger. That view has been challenged at various times this year by dovish shifts from the Fed, when it repeatedly downsized the overall size of the hiking cycle. For us as Dollar bulls, it is not whether the Fed hikes or not at a given meeting that matters, but rather what kind of overall hiking cycle it communicates, given that this has a big influence on the front-end interest rate curve. This is why dovish revisions to the “dot plot” weighed on the Dollar at various points this year.
Goldman adds, that looking forward to today’s meeting, the hurdle for additional reductions is high, even before one takes into account the prospect of fiscal stimulus in an economy that is operating close to capacity. This is because it would take six dots to move down the median number of hikes for 2017 from two to one, while it would also take six dots moving down for the 2018 median number of hikes to go from three to two. This is a higher hurdle for 2017 and 2018 than in any previous meeting over the past year, i.e., there is “Less Room to Run” for the Fed to revise the overall size of the tightening cycle down. The one possibility for a downward revision is for the longer-run median dot, where only one move lower would shift the median down. But we see this as less of an immediate policy signal compared with the dots for 2017, 2018 and 2019, where it would still take 4 dots to shift the median lower.
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A second, tangential question and completely unrelated to the Fed’s announcement, will be whether Trump will chime in – either on Twitter or elsewhere – and what his tone will be. As Art Cashin asked earlier on CNBC, “will Trump tweet hostilely, saying they hiked rates now that I’m in?” The market veteran adds that “if there’s a tweet, its tone may be just as important as the rate hike and maybe more so.“
So with that out of the way, here is a recap courtesy of Bloomberg of what some of the most prominent sellside names believe will happen today:
BNP (U.S. economics team)
- Fed to hike fed funds rate by 25bps; expect little guidance beyond what’s already in Fed’s projections
- Statement could include upgraded assessments in first paragraph, description of risks as appearing “balanced”
- No changes seen to Fed’s median dots; too early for big changes to summary of economic projections; most on FOMC will probably wait for more clarity
- “Elephant” at Yellen’s press conference is question of how Fed will respond to changes in fiscal outlook; impact remains “highly uncertain”
BofAML (Candace Browning, others)
- Market’s expectation for Fed hikes in coming years has room to rise
- Inflation “party” has started, with core PCE expected to rise to 1.9% by end of 2017, “approaching if not overshooting the Fed’s 2% inflation target”
- Economist Michelle Meyer expects Fed to hike once in 2017, three times in 2018; any signs of concern from Fed regarding USD strength would limit short-term USD gains
Citi (Dana Peterson, Andrew Hollenhorst, others)
- Fed may make few, if any, adjustments to its growth and inflation forecasts
- Renewed USD strength and back-up in yields may ultimately exert drag on U.S. growth and inflation
- Recent moves in interest rate, currency markets aren’t likely to be enough to affect Fed’s 2017 forecasts now
Credit Suisse (Praveen Korapaty, others)
- Market isn’t pricing in enough risk of Fed hikes in 2017-2018; Trump administration is likely to have passed some fiscal initiatives by 2H 2017-1H 2018
- In phone interview, Korapaty said “we will probably get a small move up in dots;” Fed’s meeting could be a “catalyst” for markets to start repricing number of hikes expected in 2017-2018, if statement or Yellen’s press conference is more hawkish than expected
Deutsche (Joseph LaVorgna, others)
- Policy makers will have little reason to lower their long-run rate forecasts further, especially since upside risks to growth have increased considerably; they will likely view their longer-run fed funds projections as “just right”
- Fed will likely be “encouraged” by convergence of markets’ outlook toward its forecasts
Goldman (Robin Brooks, Michael Cahill)
- Fed is likely to break trend of downward revision to policy rate path, marking “a turning point for the dollar”
- USD may rise after FOMC meeting
- Firm’s 12-month forecast for USD/JPY is raised to 125 from 115; 24-month forecast remains at 130
JPM (Michael Feroli)
- Statement will take no view on prospects for fiscal policy; Yellen to stress that it’s premature to change economic or Fed policy outlook
- No dissents expected in decision to hike
- Median dot for 2017 will continue to suggest two hikes; JPM sees no compelling reason for major changes to 2018 or 2019 dots; FOMC may take “breather” on adjusting long-term dot
Morgan Stanley (Ellen Zentner, Ted Wieseman, others)
- Trump’s economic agenda suggests Fed’s forecasts for growth and policy “look achievable,” which should lead to hikes next year in September and December; three more seen in 2018
- Fed will stick to its path for target rate for now; expect slight downward revision to NAIRU and longer-run neutral rate
- Market possibly pricing in a “decent probability” that median dots shift higher at FOMC meeting, though current market expectations are along FOMC’s projections
Standard Chartered (Thomas Costerg)
- FOMC will want to avoid any unnecessary volatility and “meddling in politics” so its economic forecasts will be little changed
- Changing its forecasts “radically” up or down would probably be seen as politically validating or rejecting Trump’s policy platform
- “Status quo could be a relatively safe option”
TD (Brittany Baumann, others)
- FOMC to emphasize its patient stance beyond December; expect little change to economic projections and unchanged pace of normalization in dots
- Base case implies “relatively quiet landing” for USD, with most of upside potential realized before meeting
- Yellen likely to mention USD strength, room for further decline in labor market slack
UBS (Drew Matus, others)
- Current distribution of dots is at risk of faster pace of tightening “across the entire forecasting horizon”
- Only two policy makers would need to move their 2017-2019 outlooks higher to produce a higher median
- Long-run forecast could move if just one forecast shifts between a 2.75%-3% rate