On Wednesday at 2pm ET, the FOMC will publish its rate decision and economic projections with Chair Powell’s press conference scheduled for 230pm ET. There will be no surprises: both consensus and the market expect (with 100% certainty) a 25bps hike to 1.75%-2.00%; where the market still has questions is about the shape of the “dots” to see if the FOMC pencils in a fourth 2018 hike: all that needs to happen is for one net dot to rise. Analysts will also watch whether the IOER will rise by only 20bps instead of 25 bps, as the last FOMC minutes discussed, any discussions on the neutral rate and whether, as per the WSJ rumor, Powell will make every meeting “live” in a hawkish switch where a press conference will follow every FOMC meeting.
TRAJECTORY: The Fed has pencilled in three hikes in 2018, three in 2019, and two in 2020; the question is whether it sees a fourth hike this year. Money markets price an 88% chance of three hikes this year, and around 44% chance of four 2018 hikes. Fed’s Bostic (voter), Kaplan (non-voter) and Harker (non-voter) have all endorsed three rate rises in 2018, while Williams (voter) and Mester (voter) are in the ‘three/four’ hikes camp, depending on data. Goldman Sachs and BofA see the FOMC projecting a fourth rate rise this year, citing hawkish comments from FOMC officials in recent weeks, and Goldman also expects the 2019 median dot to rise by a quarter point, consistent with three hikes in that year (and one more in 2020). “This 4-3-1 baseline for 2018-20 compares to the March projected pace of 3-3-2, and in our view would be a natural response to mounting evidence of a larger employment overshoot.”
NEUTRAL RATE: In the press conference, Fed chair Powell may be quizzed about the neutral rate, a subject that has featured heavily in recent Fedspeak; specifically, what level does the FOMC see the neutral rate, and how far is it prepared to overshoot it in this hiking cycle is the key area of debate. The May meeting minutes stated that “a few” officials “observed that the neutral level of the federal funds rate might currently be lower than their estimates of its longer-run level.” That estimate naturally varies among Fed officials: Bostic (voter) sees it between 2.25%-2.75%, Kaplan (non-voter) sees it between 2.50%-2.75%, Harker (non-voter) sees it between 2.75%-3.00%.
IOER: Analysts will be keeping an eye on whether the Fed raises the Interest on Excess Reserves by only 20bps not the full 25bps, as hinted at in the FOMC’s recent meeting minutes, given the Fed Funds Rate target have been creeping towards the rate of Interest on Excess Reserves (IOER), which is set towards the top-end of the target range: “The Fed has never thought the IOER rate and the top of the target range have to be coterminous, and a prospective tweak should be seen as technical,” writes UBS, “this change should be seen in the context of a longer-running debate inside the Fed about the daily operating framework for monetary policy,” and adds that “the minutes did note that the adjustment could take place at a meeting with or without a target rate change. Nevertheless, the June meeting seems like an opportune time for the Board to make this adjustment.” The rate is currently at 1.75%.
FOMC MARCH SEP VS. MARKET EXPECTATIONS
What Goldman expects the projections will look like:
And finally, this is how the economy has changed over the past 3 months:
PRESS CONFERENCES: There is a chance that the FOMC will decide to hold a press conference after every policy meeting, as opposed to quarterly press-conferences that take place in March/June/September/December, when forecasts are updated. Analysts say this would allow the Fed a degree of flexibility to adjust rates at non-SEP meetings (as has been the case in this hiking cycle), which would have the consequence of making every meeting ‘live’. Analysts at Oxford Economics believe this would be a good step, but note however that “Chair Powell says he is concerned that a press conference after each meeting would incite market participants to assume more rate hikes than currently expected. Communicating such a change clearly to the markets would be paramount.”
DOTS HEADING HIGHER: In order to reflect the upbeat growth picture and the labor market overshoot, Goldman expects hawkish changes to the dot plot. Recent public remarks by several Fed officials continued to evolve in a hawkish direction during the spring—including by previously dovish members such as Governor Brainard and influential centrists such as San Francisco Fed President John Williams. In fact, several committee members have explicitly addressed the possibility of a faster pace of hikes this year. With the exception of Williams’ June 1 remarks, all of the below quotations preceded the release of the high-flying May employment report (which brought the jobless rate to a 48-year low and may incite additional hawkish changes).
This hawkishness will manifest itself in a gradual increase in the median dot for 2018, which according to Goldman will show a total of four interest rate hikes, up from the three projected at the March meeting. What is notable is that only one member would have to boost his or her 2018 projection above the March median for next week’s SEP to show a four-hike baseline this year, an increase which is certainly likely tomorrow. Goldman also expects the 2019 median dot to rise by a quarter point, consistent with three hikes in that year and one additional hike in 2020. This 4-3-1 baseline for 2018-19-20 compares to the March projected pace of 3-3-2.
In the event that the 2018 median does not increase, Goldman still sees scope for the 2019 medians to show 7 hikes cumulatively over those two years (vs. 6 hikes in the March SEP). Said otherwise, fewer projected hikes in 2018 would increase the scope for additional ones the following year.
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STATEMENT: A number of officials, notably Williams (voter) and Brainard (voter), have argued that forward guidance may need to be changed as the neutral rate approaches, and as such, the FOMC will likely review its language around ‘accommodative policy’. The line in the statement in focus will be that rates will remain “for some time, below the levels that are expected to prevail in the longer run.”
Goldman Sachs expects the statement to retain an upbeat tone, with a constructive view on household spending, an acknowledgement of lower unemployment, and a hawkish rewording of the forward guidance. “On the negative side, with Italian sovereign spreads returning to levels last seen in the European debt crisis, we think the statement will probably include a subtle reference to heightened uncertainty abroad, echoing recent comments from Governor Brainard.” (see projected redline below).
In terms of the other key sentences, Goldman is looking for the following:
- In response to upward pressure on the effective fed funds rate, n we expect a policy directive in the statement’s implementation note that will adjust the interest on excess reserves rate (IOER). Such a change (for example, “to a level 5 basis points below the top of the target range”) was strongly suggested by the May minutes.
- We do not expect a direct reference to recently enacted tariffs nor to the prospect of additional trade restrictions. We do, however, expect these issues to come up during the press conference.
- We think Fed governor nominees Richard Clarida and Michelle Bowman will not attend next week’s meeting. Given that the Senate Financial Services Committee vote is currently scheduled for Tuesday the 12th, the odds of scheduling and holding a floor vote to confirm them in time for the meeting are very low.
- We do not expect any dissents, matching the unanimity of the March tightening action. The December dissenters (Minneapolis Fed President Neel Kashkari and Chicago Fed President Charles Evans) are non-voters this year, and we expect that even the more dovish voters on the Committee will be persuaded to support a second hike in 2018
Finally, here is Goldman’s proposal for the June FOMC statement redlined vs the May statement.