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FOMC Preview: It Should Be Boring, But…

Courtesy of ZeroHedge. View original post here.

Today at 2pm, the Fed will announce its rate decision.  No change in policy is expected and as a reminder this is a meeting that doesn’t have a press conference, nor a fresh summary of economic projections so the only focus will be on cosmetic changes to the statement.

  • Fed Funds futures show almost zero expectation for a move at this meeting versus a probability a little above 80%  in September.
  • Deutsche Bank economists expect a fairly uneventful statement with the only real change being an  acknowledgement of some recent softness in housing market data and/or trade tensions.
  • According to RanSquawk, there is a risk that the FOMC could issue a statement on the Fed’s independence, following the recent critique of high rates by US President Trump, which might be interpreted in a hawkish manner.

Some more details from RanSquawk on what to expect:

FOMC TO STAND PAT

The Fed is very likely to stand pat on policy on Wednesday, maintaining the federal funds rate target at between  1.75-2.00%; money markets price just a 2.5% chance of a rate hike in August. There will be no post-meeting press  conference with Chair Powell, nor any updated economic projections, the focus will be on the FOMC's statement. June’s policy statement was tweaked heavily, and as a result, most analysts aren’t expecting to see any major tweaks in August. The statement, therefore, will likely endorse the current trajectory of gradual hikes, where the central bank expects to lift rates on a further two occasions in 2018, in line with money market pricing (around 95% chance, according to money markets).

RECENT DATA

The tone of economic data has been evolving in line with the Fed's forecasts; Core PCE stands at 2.0% Y/Y, in line with the Fed's forecast; the advanced Q2 GDP data showed growth of 4.1%, well ahead of the Fed's 2.8% forecast for 2018, though this bounce might be an aberration. Whether this will result in a change to the Fed’s language on incoming data remains to be seen. Societe Generale believes that the Fed will continue to describe growth as rising at a “solid” rate. SocGen also argues that the Fed may adjust its language on the unemployment rate, arguing that since the June jobless rate rose from 3.8% to 4.0%, the statement will need to drop the reference to how the rate ‘declined’, which could see a return of the older language that states the unemployment rate “has stayed low.” Some have also been focussing on June's removal of the reference to the FFR target being below the longer-run neutral rate, but the general view is the Fed is unlikely to tweak its forward guidance about policy accommodation.

RATE HIKE PAUSE

While the Fed's "dots" define the neutral funds rate at 2.9%, there’s uncertainty around that projection, and the Fed’s monetary policy report in July includes estimates that would suggest they’re already very close to that level. As a result, some have expressed concern about the possibility the Fed may discuss a rate hike pause which reflects a split in the committee’s June forecasts, with eight participants favoring at least two more rate hikes this year, but seven favoring one or none. The ongoing curve flattening has added urgency to the discussion, with Fed presidents James Bullard, Raphael Bostic and Neel Kashkari raising concerns that being too aggressive on rate hikes could invert the curve.

FED INDEPENDENCE

After US President Trump recently stated he was unhappy about rising rates, suggesting that US policy normalisation would put the US at a disadvantage relative to Europe and Asia (where normalisation is proceeding at a much slower pace). Trump added that he is “letting” the Fed do what it feels best, however, which some analysts have taken to mean that the President could change his mind about his tolerance in the future, intruding on the Fed’s policymaking function. Some desks, therefore, warn of risks that the FOMC could issue a statement (either within the main policy statement, or even as an additional statement) reiterating the central bank’s independence. ING suggests that this might be interpreted as a hawkish dign, signalling the Fed’s intention to continue with a tighter policy trajectory.

TRADE TENSIONS

Naturally, there will be an eye out to see if the Fed's mentions trade tensions, particularly after the latest Beige Book showed tariffs remain the largest concern among businesses that were surveyed. UBS does not believe this will be mentioned after Fed Chair Powell in his recent testimony to lawmakers said these risks were being ‘monitored’; since then, trade tensions have eased after the US and Europe agreed to begin trade talks, putting escalating measures on hold. Accordingly, the Fed is under less pressure to formally address trade tensions.

YIELD CURVE

It would only take one FOMC participant to adjust their rate forecast lower for the median dot to return to three hikes in 2018 (forecasts will be updated at the 25-26 September meeting). The yield curve may provide a participant with that excuse, Rabobank says, especially since the June meeting minutes stated that a number of participants thought it would be important to continue monitoring the slope of the curve, where inversions have historically portended a recession. Rabobank argues that “June’s FOMC projections – with core PCE inflation rising only modestly to 2.1% while raising the federal funds rate to 3.4% – are a blueprint for a monetary policy mistake. Before the end of 2019, by the 5th hike from now, the Fed would invert the yield curve, and that could signal a recession in early 2021.” Others have dismissed the notion that a yield curve inversion might be a sign of an upcoming recession. UBS has said that in the 1970s, when inflation was the largest part of a bond yield, and inflation was tied to the economic cycles, yield curve inversion had predictive power. But those conditions are not in place today; furthermore, the yield curve is heavily distorted by the Fed’s large balance sheet, that was built up during the crisis, again casting some doubt on whether an inverted Treasury curve would be a sign of a downturn ahead.

INFLATION

While inflation by the Fed’s preferred PCE measure was 2.2% in June – with core inflation, excluding food and energy, at 1.9 percent – the FOMC is likely to be somewhat concerned. “As inflation has fallen short of 2 percent for more than six years, inflation can also be allowed to run above the Fed’s objective for a number of years and is expected to do so by at least a number of Fed members,” said Lindsey Piegza, chief economist at Stifel Nicolaus.

NY FED’S WILLIAMS

It is worth noting that John Williams has now taken his place as President of the NY Fed, and is therefore, the FOMC Vice Chair; that means that there is a vacancy on the SF Fed, which votes this year. As a matter of technicality, Esther George (President of the Kansas City Fed), will be the alternate voting member until a new SF Fed President has been put in place. UBS says that "even if Esther George decides to dissent in favour of a hike, consistent with her typically hawkish views, that decision would have little bearing on the decision or the path of policy.

ESTHER GEORGE

As Bloomberg reminds us, there will be a shift among voters this meeting. The San Francisco Fed is looking for a new president after former chief John Williams relocated in June to run the New York branch. As a result, Kansas City’s Esther George will cast San Francisco’s FOMC vote until a new leader has been installed, though interim president Mark Gould will attend the meeting and speak on its behalf. George, one of the most hawkish FOMC participants, recently endorsed continued gradual rate hikes, while saying an inverted yield curve may not necessarily be an economic signal.


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