A new era for US central banking began on 20-21 March as Federal Reserve chairman Jay Powell presided over his first policymaking meeting.
The meeting of the Federal Open Markets Committee unfolded largely as expected. The FOMC raised the range for the target federal funds rate by 25bp to a range of 1.50%-1.75% and signalled it expected inflation to rise in the coming months due to base effects and recent strong data.
The Summary of Economic Projections also conformed to market expectations, with median participants projecting stronger growth, a lower unemployment rate and slightly firmer inflation, which in turn require a steeper path for policy rate increases over the projection horizon.
Powell FOMC: in line with expectations and then a faster pace
Before the first meeting by the Powell FOMC, there had been considerable market debate about whether the median policy rate projection for 2018 would reflect 100bp or ‘just’ 75bp of anticipated tightening. In the end, and in line with our expectations, the median 2018 projection was unchanged at 2.1 %, reflecting 75bp of total tightening – see Exhibit 1 below.
We continue to expect this median to move higher in June, and thus remain comfortable with our call for 100 basis points of tightening this year.
Exhibit 1: The dots are going up!
FOMC participants’ assessments of appropriate monetary policy (midpoint of target range or target level for the fed funds rate) at March 2018 meeting, December 2017 FOMC meeting and marketing pricing of fed funds futures contract as of 21/03/18
In our view, too much attention has been paid to the issue of three versus four rate rises in 2018 as reflected by the median projection. More importantly, the FOMC is signalling that it is increasingly confident that it will have to take the policy rate into restrictive territory, and sooner than previously thought.
The median policy projection for end-2019 now sits at the FOMC’s estimate of the longer-run neutral rate (also see here). But most participants do not expect the neutral rate to have risen to its longer-run value by then.
Hence the 125bp of additional tightening projected between now and end-2019 suggest that the policy stance will turn restrictive next year (especially given additional tightening through the balance sheet run-off). The stance becomes even more restrictive in 2020 – the Fed’s median-projected fed funds rate for the end of 2020 is 3.4%, 50bp above the median estimate of its longer-run neutral value.
Indeed, the tighter policy stance that will be required to prevent overheating in the years ahead suggests rising recession odds over the next several years. Powell seems aware of this risk, and in his press conference stressed that the FOMC is trying to walk a middle ground between raising rates too quickly (which could prevent the FOMC from achieving its inflation objective on a sustainable basis), and raising rates too slowly (which would risk a sizeable inflation overshoot and much more restrictive policy down the road).
We suspect that this middle ground will lead to inflation running a bit above the 2% objective in the years ahead, and that eventually, the FOMC will need to raise rates more quickly to bring inflation back to target. Indeed, the median participant now projects inflation to run a tenth above the 2% objective in both 2019 and 2020. One could argue that the suite of changes to the economic projections already requires a steeper policy rate path than that implied by the median participant.
Powell: more succinct, but also more superficial
There were few significant insights in Powell’s first press briefing. He proved less willing to go into details than his predecessor, keeping his responses brief and fairly superficial, and also shared much less of his own views compared to his Congressional testimony. Not surprisingly, he dodged questions on trade and fiscal policy, but expressed hope that corporate tax reform will promote higher trend growth while also stressing uncertainty over the size and timing of any such effects.
On the margins, these considerations do seem to be impacting the economic projections. The median estimate of the longer-run policy rate ticked up by a tenth, and while the trend growth projection remained at 1.8 percent, the top of the central tendency range moved a bit higher. Possible revisions to r* and trend growth will become an increasingly important narrative as the year unfolds, and further upward revisions to r* would imply that the Committee needs to raise rates a bit more quickly over the next few years.
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