Your Last Minute FOMC Preview: “Will It Be A Dovish Hike Or Not”
Courtesy of RanSquawk
- The FOMC is seen raising the Fed Funds Rate target by 25bps to 1.00-1.25% at 1400EDT, but the main focus will be on the hike trajectory
- Updated economic projections will be published, and there will be a post-meeting press conference with Chair Janet Yellen
- Analysts aren’t expecting any dramatic changes in the Fed’s updated forecasts and ‘dot-plots’
- Traders will be looking out for details on how the Fed intends to begin shrinking its balance sheet
- Rate decision announced at 1400EDT (1900BST) along with updated forecasts; press conference with Chair Yellen begins at 1430EDT
RATES: MARKETS AREN’T BUYING INTO THE FED’S TRAJECTORY
- The FOMC is expected to raise its overnight federal funds rate (FFR) target by 25bps to 1.00% to 1.25%, in what would be its second hike of 2017. Fed Funds Futures were pricing in a 95% implied probability that rates will be lifted – at one point last week, that probability was over 99%.
- With the rate rise pretty much a done deal, the focus is likely to be on the Fed’s rate hike trajectory. Currently, Fed Funds futures aren’t buying into the Fed’s forecasts which looks for a total of three hikes per annum in 2017, 2018 and 2019. The December 2017 contract implying a rate of 1.25% (suggesting just two hikes in 2017); 1.51% at the end of 2018 (suggesting just two hikes between now and the end of 2018); and 1.695% by the end of 2019 (suggesting three hikes between now and then).
- Given that the rate hike is so heavily discounted, the market reaction isn’t likely to take its cues from the rate hike; instead it will look to the FOMC’s projections of the rate path, and perhaps its balance sheet reduction pace. Consequently, if the central bank refrained from lifting rates, an aggressive, dovish market reaction may be likely.
LABOUR MARKET: CONTINUES TO STRENGTHEN
- The labour market continues to tighten, and with the exception of the Fed’s dovish Neel Kashkari, voting members of the FOMC seem to be encouraged by the progress.
- While the pace of monthly nonfarm payroll additions has slowed, the rate of joblessness has fallen to a 16-year low at 4.30%, and beneath the Fed’s current estimate of NAIRU (non-accelerating inflation rate of unemployment). Even the U6 measure of underemployment has fallen to the lowest since 2007.
- The most recent JOLTs data, one of the FOMC’s favoured measures of labour market health, rose above six million openings for the first time. Oxford Economics’ analysts say the data shows job openings are now outpacing hiring, and this suggests that companies are having a hard time finding qualified workers amid a tight labour market.
Recent FOMC Labour Market comments:
- FOMC May 2017 Statement: The labor market has continued to strengthen even as growth in economic activity slowed
- FOMC May 2017 Statement: Job gains were solid, on average, in recent months, and the unemployment rate declined
- FOMC May 2017 Statement: Labor market conditions will strengthen somewhat further
- Fed’s Brainard (voter): Labour market strength has outstripped what most researchers see as steady state (23/May)
- Fed’s Kashkari (2017 voter): May be more slack in the labour market (23/May)
- Fed’s Harker (2017 voter): There is very little labour market slack left in the US (2/Jun); Labor market at full health (12/May)
- Fed’s Kaplan (2017 voter): There is not a lot of slack left in the labour market (30/May); US approaching full-employment (20/Apr)
- Fed’s Yellen: Labour market now at normal state (10/Apr); Labour market participation sign of improving conditions (15/Mar)
INFLATION: FED EXPECTED TO LOOK-THROUGH THE WEAKER INFLATION PROFILE
- In contrast to the firming labour market, inflation data, especially after today’s third consecutive CPI miss, has been moving away from target. PCE inflation – the FOMC’s preferred gauge of price pressures – have been easing since Q1 and at 1.70%, currently lies at the bottom-end of the Fed 2017 central tendency estimate. Core PCE, meanwhile has fallen beneath the central bank’s central tendency forecast at 1.50%.
- Market gauges of inflation have also been coming off, as seen by the 2y2y and 5y5y inflation swap forwards, which have both been steadily falling as traders become sceptical about the prospects of Trump’s fiscal agenda materialising in the short-term; the 5y5y measure has nearly wiped-out the ‘Trumpflation’ bounce it saw since November 2016.
- Consumer gauges of inflation have also been falling. The NY Fed’s most recent survey found consumer expectations falling to the lowest levels since early 2016, with the survey noting “inflation uncertainty” among respondents.
- Analysts at Deutsche Bank believe that the Fed will address the weak profile of inflation: “They could note that inflation has eased recently, and if so will likely also say that they view this easing as being largely transitory,” the bank writes, adding “the centre of the Committee likely remains reasonably confident that solid growth momentum and further progress in the labor market should keep inflation on track despite the recent downside inflation surprises.”
Recent FOMC inflation comments:
- FOMC May 2017 Statement: Inflation measured on a 12-month basis recently has been running close to the Committee’s 2 percent longer-run objective.
- FOMC May 2017 Statement: Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed
- FOMC May 2017 Statement: inflation will stabilize around 2 percent over the medium term
- Fed’s Harker (2017 voter): Inflation still on track despite recent softness; sees it hitting Fed’s 2% inflation goal around the end of 2017 (2/Jun)
- Fed’s Powell (voter): Good reasons to predict rebound in inflation, slow inflation progress means Fed should be patient with hikes (1/Jun)
- Fed’s Kaplan (2017 voter): Uneven recent inflation a concern, but price pressures likely building, inflation not ‘running away’ from Fed (1/Jun)
- Fed’s Brainard (voter): Lack of progress on inflation ‘a source of concern’, may want to delay hikes if inflation continues to slow (30/May)
- Fed’s Evans (2017 voter): Sees a serious ‘miss’ on the Fed’s inflation target from 2009 to now; could be ok with one more hike if there are more uncertainties about the inflation outlook (12/May)
- The divergence in the performance of labour market and inflation data, combined with aggressive market pricing, has presented the Fed with a conundrum. As such, many analysts are expecting a so-called “dovish hike”.
- Analysts at Bank of America Merrill Lynch believe the Fed will attempt to deliver a dovish hike, where a 25bps rate rise will be accompanied by unchanged dot plots, while the statement will continue to reiterate weakness in inflation is transitory.
- “This would go hand-in-hand with a downward revision to core PCE inflation this year, but maintaining the 2% forecast for next year. We also think the unemployment rate will be revised lower, but as will the Fed’s estimate of NAIRU.”
- BAML also believes that the delivering the so-called dovish hike may prove challenging: “Subdued rate expectations suggest it may be challenging for the Fed to communicate a dovish hike, given the recent shift in market pricing,” the bank says, adding “this could raise policy mistake risks shown in the rates market and lower inflation breakevens. USD impact is expected to be muted, but a negative surprise could come from lower dots.”
FOMC UPDATED PROJECTIONS: UNLIKELY TO SEE MAJOR ADJUSTMENTS
- Analysts are more-or-less in-line with the Fed’s view of growth this year, though are slightly more optimistic in 2018 and 2019, leaving scope for upward biases to the Fed’s growth projections.
- Analysts and the FOMC are generally in-line with each other. It will be interesting to see whether the Fed lowers its assessment of NAIRU given the current low unemployment rate is failing to stoke inflationary pressures.
- Inflation is the area where the Fed may make notable changes to its forecast. The consensus view is 0.2ppts softer than the Fed’s forecast for 2017, though is generally in-line for 2018-19.
- Fed funds are not pricing in a hike trajectory as aggressive as the Fed foresees.
BALANCE SHEET PLANS
- The FOMC has signalled its intentions to begin the process of balance sheet normalisation, and in May’s minutes proposed setting a fixed amount that would be allowed to ‘run-off’ from the balance sheet from maturing securities that it holds, with that level being lifted over time – as the levels are raised, reinvestments will decline.
- But save for the pledge that such normalisation would be conducted in a “gradual and predictable manner”, the logistics remain unclear: when will it begin; what will the ‘cap’ be set at; what size does the Fed want to shrink its balance sheet to, and over what timeframe; how will balance sheet normalisation impact the rate hike trajectory, etc.