A Little More Confidence that Inflation Will Reach 2%

The statement reflects the FOMC’s increasing but guarded, confidence that inflation will reach 2%. The tone continues to suggest that, with inflation still below target, there is no need to rush normalization.  Today’s statement does not change our thinking about the pace of rate hikes. 

The most interesting changes related to the assessment of inflation. Collectively, these changes suggest to us that, at the margin, the FOMC is more confident that inflation will move to 2% in the medium term. 

▪ First, inflation no longer gets a separate sentence in paragraph two. Now inflation (“will rise to 2  percent over the medium term”) is lumped together with the characterization of growth (“expand at a  moderate pace”) and the labor market (“strengthen somewhat further”). 

▪ Second, the statement no longer makes an excuse for low inflation. In recent statements, the FOMC  has said inflation was expected to rise as the effects of earlier declines in energy and import prices dissipate. They now apparently see these effects as having largely dissipated.  

▪ Third, the FOMC disconnected the direct link between a further strengthening in the labor market and the accompanying expectation of inflation rising to 2% over the medium term. Any import here? We have long said that the labor market does not need to tighten appreciably further for inflation to gradually rise to 2%. That is the verdict from the Phillips curve, with little or no slack currently and only a modest further decline in the unemployment rate ahead! 

The other significant change was the addition to the first paragraph of a sentence that noted, “Measures of  consumer and business sentiment have improved of late.” We interpret this as a possible sign that the  FOMC sees a return of favorable animal spirits, or at least fading headwinds, less caution, and less risk aversion.  

▪ The statement does not usually refer to measures of sentiment, preferring to focus on the harder data.  ▪ But the post-election rise in sentiment measures is notable. Perhaps they reflect a return of positive animal spirits, or at least diminished caution and risk aversion that might provide a boost to household and business spending. 

With the most important messages from the FOMC out of the way, we’ll make a couple more observations. 

▪ The FOMC opted to retain the sentence on near-term risks appearing “roughly balanced.” The FOMC’s approach appears to be: Don’t rock the boat and implicitly comment on how the Trump presidency may be affecting the balance of risks to the outlook—leave the language on risks unchanged.  

▪ Discussions on “Statement on Longer-Run Goals and Monetary Policy Strategy” occur at the FOMC’s annual organizational meetings each January. There was no dedicated press release that was published concurrently with the FOMC statement, suggesting that no substantive changes were made today.  Instead, the minutes of this meeting (which will be published on February 22) will likely note that the 

strategy statement was affirmed, perhaps with minor revisions and updates. (Previously, the only time a  press release was issued for an update to this statement was in January 2016, when the symmetric  nature of the inflation objective was made explicit.) 

No change in our FOMC call: Three hikes this year, with no hike in March. But a hike in March is certainly not off the table. We see the probability of a hike in March as a bit less than one-third. The most important data releases for the prospects of a March hike are the upcoming employment reports. 

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