The central question surrounding today’s meeting was whether the recent run of low readings on price inflation would be raising anxiety within the Committee about the prospects for returning inflation to target in a reasonably timely manner. That question took on greater salience after this morning’s surprisingly soft core CPI figures. Well, judging by the FOMC statement and the accompanying economic projections, the answer appears to be “not yet.” The forecast for inflation was unchanged, and the median dots for the federal funds rate still showed an expectation of three hikes this year, three hikes in 2018, and three hikes in 2019. We are making a modest adjustment in our FOMC call—more in response to this morning’s inflation data than to the statement [link]. We continue to expect three hikes this year but have delayed the third hike from September until December, on the thought that this will give the Committee a bit more time to assess the inflation outlook. We still expect an announcement about the timing of the phasing out reinvestment to occur in September. The release today of an addendum to the Policy Normalization Principles and Plans reaffirms that there is a high probability that they make a firm announcement in September, even though there weren’t any revelations on timing in the document itself.
The statement remained upbeat about labor market developments and economic activity. Correspondingly, the median GDP projection of FOMC participants has actually raised a tenth for 2017, and the path of the unemployment rate was lowered by about ¼ percentage point across the forecast period.
▪ Much as we had expected, the statement indicated that the Committee was not concerned about the slower growth of payroll employment in recent months. Indeed, they gave even less ground than we anticipated. While they acknowledged that job gains had “moderated,” they characterized those gains as having been “solid” thus far this year. And they maintained the language that noted “the labor market continued to strengthen” and cited the further decline in the unemployment rate.
▪ The statement described the growth of overall activity as “rising moderately” and the GDP projections of FOMC participants anticipate that growth will remain above potential through 2019. As we had anticipated, they noted the pickup in household spending and the continued expansion of business fixed investment. The FOMC apparently does not yet share the concern about the growth of some outside forecasters who have been marking down their forecasts for the second quarter.
Taken together, the statement and the FOMC projections reveal a Committee that is watching inflation developments closely but is, as yet, giving a relatively little signal to the recent low readings on price inflation.
▪ In the first paragraph, the statement notes that headline inflation has declined recently and, like the core measure, “is running somewhat below 2 percent.” Thus, despite today’s further drop in the 12-month change in the core CPI, they continued to characterize inflation (headline and core) as being only “somewhat” below target.
▪ In the second paragraph, they express confidence that inflation will stabilize around their 2 percent objective over the medium term.
▪ And judging from their projections, the medium term is not that far away. To be sure, they did lower their projection of headline PCE price inflation by three tenths and their projection of core inflation by two tenths this year. But FOMC participants’ median projections of both headline and core inflation show a return to 2 percent in 2018 and 2019—unchanged from their March projections. So the lower readings on recent inflation have no persistence in the FOMC’s forecasts.
▪ The unchanged projections for inflation could reflect the offsetting effects of a lower path for the unemployment rate. The median projection for the unemployment rate was reduced by two tenths this year and three tenths in 2018 and 2019. The median projected NAIRU fell a tenth, to 4.6%. Yellen stressed in the Q&A portion of the press conference that the FOMC viewed the tightness of the labor market and the expectation of continued strengthening of the labor market as putting in place conditions that would result in inflation moving up.
▪ Still, we find it quite notable—and policy-relevant—that FOMC participants have made no adjustments to their inflation forecasts beyond 2017 in response to the appreciable shortfall in the recent readings on core inflation.
▪ Tellingly, Yellen stuck with the transitory explanation in her opening remarks to the press briefing. She noted, “the recent lower readings on inflation have been driven significantly by what appear to be one-off reductions in certain categories of prices, such as wireless telephone services and prescription drugs.” She concluded, “we are focused on making our policy decisions on the medium-term outlook (our emphasis).”
That relatively relaxed attitude to the recent low readings on inflation and the view that these data do not signal some downshift in inflation behavior was reflected in their outlook for a policy as well. The median dots for the federal funds rate were, in Yellen’s words, “essentially identical.” They continue to indicate that the Committee anticipates three hikes this year, next year, and in 2019. So the “steady hand” of the FOMC still looks steady to us.
▪ For 2017, the dots are now distributed symmetrically around three hikes: eight at three hikes and four at both two and four hikes. One reason the lower end of the distribution is now closer to the median is (understandably) that no FOMC participant now expects only one hike this year. The range of dots for 2018 also narrowed.
▪ The median dot for 2019 edged down by half a hike; nonetheless, we would interpret the consensus for the pace of tightening in 2019 to be three hikes.
▪ The median longer-run dot remained at 3 percent, although Yellen noted the uncertainty surrounding this estimate and a widely-held view that the current r-star is lower. As in March, more participants were below the median than above.
The Committee also issued an “Addendum to the Policy Normalization Principles and Plans.” The details were broadly in line with our expectations [link].
▪ The most notable aspect of this addendum was its timing; its publication today reaffirmed our view that there is a high probability that they will make a firm announcement in September. The same was true of Yellen’s comment that “if the economy evolves in line with our expectations…we could put this into effect relatively soon” (our emphasis).
▪ Both Yellen and the addendum revealed that the FOMC has not yet determined what the eventual quantity of reserves will be. Yellen said, “Decisions about the appropriate long-run framework do not need to be made for quite some time…At this point, I’ll just point out that our current system is working well and has some important advantages.” The addendum stated: “the [ultimate] level will reflect the banking system’s demand for reserve balances and the Committee’s decisions about how to implement monetary policy most efficiently and effectively in the future.”
▪ Regarding speculation that the FOMC would refrain from both tightening via a rate hike and beginning runoff at the same meeting, Yellen responded that “we have made no decision about that and it really hinges on the outlook and our assessment of conditions.” Given the apparent inclination of the FOMC to begin runoff “relatively soon,” it would be premature to rule out the option of hiking at that meeting.
▪ Yellen echoed the views of several FOMC participants who preferred that runoff proceed on autopilot or, as Yellen put it, be “something that the Committee will not be reconsidering from time to time.”
▪ The table below outlines the proposed profile of runoff caps. The news today was the size of the caps.
|Months After Start of Runoff||Cap on Treasuries Runoff ($billion per month)||Cap on MBS and Agency Debt Runoff ($billion per month)|
|13 onwards (maximum caps)||30||20|
While you may begin to tire of hearing it, our theme of the “steady hand” at the FOMC has served us well thus far this year and appears to remain intact. Despite several months of surprisingly low readings on core inflation (as well as somewhat slower gains in payroll employment and less-than-impressive data on private spending), the FOMC expects the normalization of rates to proceed at the same pace that was anticipated in March. We expect the Committee to be able to follow through with its normalization, and we still forecast one more fund’s rate hike this year. But we do think, in light of today’s additional surprisingly small increase in core prices, that the FOMC will defer that third hike until December; our previous expectation had been that it would occur in September. Nevertheless, given the issuance of the addendum to its normalization principles and plans, we still see the Committee as firmly on track to announce a start to the gradual end of reinvestment at the September meeting. So, all told, all systems remain to go on interest rate and balance sheet normalization.
Projections of inflation and growth in the real gross domestic product (GDP) are for periods from the fourth quarter of the previous year to the fourth quarter of the year indicated. Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.
*LH Meyer forecast published June 8, 2017.