Growing Confidence in the Outlook

A lot has happened since the January FOMC meeting. There was about of market volatility following the  January employment report, with Treasury yields rising and equity prices falling sharply, though the latter later reversed much of the decline. Shortly thereafter, Congress passed the Bipartisan Budget Act of 2018, a  massive new source of fiscal stimulus. The incoming inflation data have been firmer, and the employment data have been consistently strong. The outlook for growth appeared to be strong even before the passage of the spending bill. Powell was sworn in as Chairman and gave his first testimony to Congress in his new position. His comments reflected that improvement in the outlook, as did the comments of other FOMC  participants, most notably Governor Brainard. While FOMC participants generally avoided explicitly saying they expected more rate hikes, it was clear that they saw upside risks to the FOMC’s median projected path from December. 

When Chairman Powell appeared before Congress for his first semiannual monetary policy testimony as  Chairman (link), the outlook had clearly improved, and he didn’t shy away from saying so: “My personal outlook for the economy has strengthened since December” (2/27). In particular, since the December meeting  “what we’ve seen is incoming data that suggests a strengthening in the economy. We’ve seen continuing strength in the labor market. We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target. We’ve also seen continued strength around the globe, and we’ve seen  fiscal policy become more stimulative.” His testimony provoked a hawkish response from the market even though his message that the outlook had improved since the December meeting should have come as no surprise. 

Powell was also asked about his views on tariffs, which the Trump administration had recently announced.  Speaking about tariffs in general, he argued that “trade is a net positive. It spreads productivity.” He  acknowledged that trade could have adverse distributional consequences, but said, “The best approach is to  deal directly with the people who are directly affected, rather than falling back on tariffs.” Other FOMC  participants made similar comments about trade. Dudley (3/1) said, “Our focus should be on further  strengthening an open trade regime, and, as appropriate, amending and improving these agreements.” He  also addressed the impact of tariffs on prices: “If tariffs go up, it will, at the margin, tend to put more upward  pressure on prices, and those upward pressures on prices will have to be considered.” 

The second most high-profile public remarks by a Fed policymaker were from Governor Brainard (link), and they revealed a shift toward the center of the FOMC (3/6). Previously, she had been the intellectual leader of the dovish side of the FOMC, focused on the uncertainty surrounding the expectation that inflation would reach 2% as early as reflected in FOMC participants’ median projection and emphasizing the importance of ensuring that it is brought up to its objective. She said that she now had “greater confidence” in the inflation  outlook: “Although last year we faced a disconnect between the continued strengthening in the labor market  and the step-down in inflation, mounting tailwinds at a time of full employment and above-trend growth tip  

the balance of considerations in my view.” While she continued to note the benefits resulting from an improving labor market, she also warned about possible risks: “If the unemployment rate continues to decline on the current trajectory, it could fall to levels that have been rarely seen over the past five decades.  Historically, such episodes have tended to see elevated risks of imbalances, whether in the form of high  inflation in earlier decades or of financial imbalances in recent decades.” 

Brainard was one of many policymakers to cite expansionary fiscal policy as an important driver of the stronger outlook for growth (3/6). She stated, “The most notable tailwind is the shift in America’s fiscal policy stance  from restraint to substantial stimulus in an economy close to full employment.” She cited estimates suggesting  that recent tax legislation could boost real GDP growth “as much as 1/2 percentage point this year and next.”  Mester said the tax cuts might add between a quarter to a half percentage point to growth over the next couple of years (2/13). Dudley (3/1) said, “Fiscal policy is in the process of turning quite stimulative, and so  any worries you had about U.S. economic growth, which I think we’re already pretty subdued, I would think  in the near term should be even more subdued.” Williams suggested that the tax cuts could influence his estimate of the neutral real fund’s rate: “I still think we’re in the realm of a movement in r* that might be at most a quarter of a percentage point” (2/23). 

Equities dropped sharply following the January employment report, and even before they recovered much of that decline policymakers downplayed the significance for the overall outlook. Mester (2/13) said, “While a  deeper and more persistent drop in equity markets could dash confidence and lead to a pullback in risk-taking  and spending, the movements we have seen are far away from this scenario.” Policymakers stressed that equity prices remained at high levels, having lost only a small portion of recent gains and that overall financial conditions remained highly accommodative. In his prepared remarks for his testimony, Chairman Powell (2/27)  noted that “Despite the recent volatility, financial conditions remain accommodative,” without specifically referencing equity prices. When asked about stock market volatility, he responded that the Fed doesn’t  “manage the stock market.” 

A consistent theme across policymakers’ remarks was that the stronger outlook and reduced downside risks pushed in the direction of tighter monetary policy than otherwise, though most didn’t reveal where their  March dots would be. Many policymakers continued to discuss the pace of rate hikes for 2018 by referring to the median projected pace of three. They generally described the pace as acceptable, but they discussed risks to that outlook and hinted at how their views might diverge from that path. For example, Kaplan (2/2)  emphasized the upside risk to his baseline view of three hikes: “If there’s a likelihood that I’m wrong, we may  have to consider doing more…You will see some inflation pressure this year.” Williams said his view of three or four hikes this year was “still reasonable” (2/2). President Dudley (3/1) didn’t say his baseline had moved  to four hikes, but he did say that “if you were to go to four 25-basis-point rate hikes, I’d think it would still  be gradual.” President Bostic (3/7) revealed that he had shifted his baseline for 2018 from two hikes to three.  Harker (2/21) said that he had still “penciled in two hikes for 2018.” However, he said that he was “open to three” because of increased upside risks (2/8). Mester (2/13) said that “If economic conditions evolve as  expected, we’ll need to make some further increases in interest rates this year and next year, at a pace similar  to last year’s.” However, she noted that “I think that there are more salient upside risks to the forecast than  we’ve seen in quite a while” and policymakers would “have to be very observant of how the economy is  evolving.” 

Evans acknowledged the stronger data but retained his dovish positioning relative to his colleagues, continuing to argue that the FOMC should “wait a little longer” and be “extremely careful” with rate hikes (3/9). Likewise,  Bullard acknowledged the change in the outlook but warned against tightening too quickly, saying “you would not have to go very high in this environment to be in a restrictive policy stance” (3/11). Harker (2/8), explaining  why his baseline was only two hikes this year, said that he’d “like to see us slightly overshoot our 2% inflation 

target.” Rosengren (3/9) and George (3/8) discussed how risks had shifted to the upside and warned about  overheating. Rosengren said those considerations made him support a pace “a bit faster than three.” 

An increasing number of policymakers discussed the prospect of inflation rising above its objective without  expressing alarm or even discomfort with the prospect of a modest overshoot. Their tone did vary somewhat,  however, with some saying that such an overshoot would be a desirable outcome and others only saying that  they saw the possibility of such an outcome. Brainard (3/6) said, “Of course, it is conceivable we could see  a mild, temporary overshoot of the inflation target over the medium term,” adding that, “If such a mild,  temporary overshoot were to occur, it would likely be consistent with the symmetry of the FOMC’s target  and could help nudge underlying inflation back to our target.”

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