Happy Days Ahead…Maybe

Summarizing the outlook: 

• The economy is in a good place, and the outlook is favorable. 

• Monetary policy is a good place, as long as there is no material change in the outlook. But… 

• Forecasts are always wrong. 

• Don’t neglect the possibility that the fund’s rate will hit the zero lower bound over the forecast horizon. • The economy is slowing, but to trend or to below trend? Could the economy slide into recession?  Think stall speed

• Core inflation headed toward 2%–we think. The data have been softer recently, but we should still get to “near” 2% in the first half of next year. 

• Risks to growth are still to the downside and risks to inflation in the near term are also to the downside. No funds rate cut at this meeting, so the focus is on communication and the macro and rate projections. • Don’t expect to hear much new. In particular, we don’t expect anything much more specific on what would constitute a “material” reassessment of the outlook. 

Little change in the statement. 

• Macro projections and dots will reinforce the narrative. 

• Not much for Powell to add at the press conference. 

The October minutes indicated that discussion of the Statement on Longer-Run Goals and Policy Strategy would begin at this meeting. 

• The Statement is updated each year at the January meeting–whether it’s simply reaffirmed or features  revisions. 

• But what is there to say in January, well before the Review is completed? 

Still, there’s plenty of time at this meeting to continue discussion of the Review. 

• The discussion is starting to get interesting! 

• The October minutes revealed an assessment of strategy and tools used in the post-financial crisis  period. 

• There were also hints of innovations to strategy (makeup) and tools (rate caps). • It’s getting to be time for participants to begin sharing their views on revisions to the framework. • Did Brainard’s talk let the cat out of the bag? 

OUTLOOK CONTEXT 

There does not seem to have been much change in the macro outlook recently. Indeed, the same could be said for the last year or so, at least for where the economy seems to be headed over the medium term. The initial conditions are mostly remarkable: Growth modestly above trend in the eleventh year of the expansion and the unemployment rate at near a 50-year low. The only black mark on the initial conditions is that core inflation, since dropping below 2% in 2008, has essentially remained below 2% since then, briefly touching  2% on only a couple of occasions. The outlook is mostly favorable. Growth is expected to slow, but only marginally below trend. The unemployment rate may rise, but just a few ticks. And core inflation returns to  2% (or very close to 2%) next year. Monetary policy is appropriate and aligned with the macro outlook. It is likely to remain so, short of a material change in the outlook. A couple of questions we ponder are: How improbable is such a soft landing, particularly a gradual, benign rise in the unemployment rate? What would constitute a material change in the outlook? Of course, there are always many questions about the outlook,  and it’s important to remember that forecasts are always wrong! 

The Mantra: All together, please. 

• “The economy is in a good place, and monetary policy is as well. My forecast is for moderate GDP  growth, the labor market remaining strong, and inflation moving back to our symmetric 2% target” – Williams 

• “Current stance of monetary policy is likely to remain appropriate as long as incoming information  about the economy remains broadly consistent with our outlook” and “if developments emerge that  cause a material reassessment of our outlook, we would respond accordingly” -Powell 

Those are just a couple of the many examples of policymakers repeating a very similar mantra. 

Still, Questions Abound 

They always do. 

First, tracking estimates for Q4 growth have been low, though they’ve moved up closer to a trend-like pace over the last couple of weeks or so. We don’t give much weight to these at this point in the quarter, but they become increasingly meaningful as more data is wrapped in. 

Second, Q4 aside (never worry too much about one quarter), it continues to look like there’s a slowdown,  from 2½% in the first half to closer to 2% in the second half. That would leave growth above trend for this year as a whole. But where do we go from here? Does that trend portend a further slowing, to below-trend growth next year, and ultimately result in a slight upward trend in the unemployment rate not too much later? 

Third, core inflation remains below 2%: 1.6% over the last 12 months. Even if core PCE prices rise at a very firm 3% annualized rate in November and December, core PCE inflation in 2019 on a Q4/Q4 basis would just barely round up to 1.7%–still clearly below 2%. This has been the case for most of this long expansion. We seem to always end the year projecting 2% by the following year. But what if we are wrong again? 

Fourth, the Committee is focused intently on measures of inflation expectations. Clarida says inflation expectations are at the low end of the range he judges as consistent with price stability. Brainard said the 

experience of frequent or extended periods of low inflation at the zero lower bound risks eroding inflation expectations and further compressing the conventional policy space. What happens if expectations erode further? 

Fifth, and perhaps it’s time to pay more attention to this: Have risks to financial stability increased? Not in the banking system, but outside the banking system, in the shadow banking system, and in the markets, the corporate bond market in particular. Where are all the leveraged loans? This may not precipitate the next recession, but the unwinding of these imbalances will almost surely exacerbate it. 

Participants Update Their Macro Projections 

Participants will update their macro projections at next week’s meeting. There will be some notable changes to the 2019 projections to reflect the incoming data. In particular, core inflation and the unemployment rate will be marked down for 2019. But the median macro projections at the September meeting were not much changed from a year ago, at least in terms of where they ended up, and we expect this general pattern to continue in the December projections. For 2020-2021, growth moderates, to trend or slightly below. The unemployment rate edges up a couple of tenths, now from a lower jumpoff, ending up well below the NAIRU.  Core inflation is within a tenth or so of its 2% objective. 

The unemployment rate was 3.6% in October, the first month of the fourth quarter. The median projection for 2019:Q4 will be 3.5% or 3.6%, and it is will likely hinge on what tomorrow morning’s jobs report for November shows. Regardless, it will likely still rise a couple of tenths from there over 2020-2022. Risks to the median longer-run estimate of the unemployment rate have been to the downside for a while now. With core inflation having to come in soft and the unemployment rate has moved down further, we expect that median estimate to edge down a tenth, to 4.1%. 

With core PCE inflation likely projected to be only 1.6% in 2019, there’s a chance some of that weakness  gets carried forward into the 2020 median core inflation projection, previously at 1.9%. But we think they’ll  stay there. 

December 2019 (Expected)

2019 2020 2021 2022 Longer run
Real GDP Growth 2.2 2.0 1.9 1.8 1.9
Unemployment Rate 3.5 3.5 3.6 3.7 4.1
Core PCE Inflation 1.6 1.9 2.0 2.0

Derek Tang 202-794-7356 derek@lhmeyer.com 3 

September 2019 

2019 2020 2021 2022 Longer run
Real GDP Growth 2.2 2.0 1.9 1.8 1.9
Unemployment Rate 3.7 3.7 3.8 3.9 4.2
Core PCE Inflation 1.8 1.9 2.0 2.0

September 2018 

2019 2020 2021 Longer run
Real GDP Growth 2.5 2.0 1.8 1.8
Unemployment Rate 3.5 3.5 3.7 4.5
Core PCE Inflation 2.1 2.1 2.1

The Dots: Median Rate Projections Consistent with the Narrative 

▪ After three cuts already this year, no one seems to have the inclination for another cut in 2019. So a  uniform distribution for 2019 is expected. We don’t see anyone projecting further cuts in 2020 and beyond either. 

▪ As for 2020, we expect a fair number of participants to project at least a partial reversal of the 2019  cuts, perhaps reflecting an interpretation that they were “insurance” cuts. However, we don’t expect there to be enough in this group to push the median toward a hike; we are fairly confident the median will show no hike in 2020. 

▪ In 2021 and 2022, we expect the median dots to gradually rise toward the longer-run dots. ▪ The longer-run dots are due for a downward drift, in our opinion. The median is likely to decline to 2.25%. ▪ No hike in 2020, one hike in 2021, and one hike in 2022 would bring the funds rate just up to a  downwardly-revised longer-run funds rate of 2¼%. 

FOMC Call 

Not much new for the FOMC to say about the outlook or monetary policy for that matter. The narrative is in place, and it’s fixed. Just don’t rock the boat. The main question to consider is this: What would a material change in the outlook, one warranting a reconsideration of the policy rate, look like? In any case, given that the outlook for the economy and monetary policy hasn’t changed much since the previous meeting, there will be plenty of time for an extended discussion of the Review. The Subcommittee on Communications may be close to reporting its recommendations. We think this may be close given how comprehensive and well 

thought-out Brainard’s “preliminary” thoughts were. In any case, if the findings from the Review are to be reported by mid-2020, there may be only several meetings, including next week’s, to ponder and reach a  consensus on the revisions. However, if the revisions are to be substantial, it may take longer to reach a  consensus, and the odds favor a conclusion later than mid-2020. 

No Rate Cut, Today or Tomorrow 

Monetary policy is in a good place, given the initial conditions and the favorable outlook. So we are not in a  pause. The Committee is not being patient. It simply has no reason to lower or raise the fund’s rate. Still, we see the risks as decidedly toward lower rather than higher rates. Inflation is low, unlikely to rise enough to warrant a rate hike, and growth seems to be slowing. That slowdown, if it persists, could raise concerns about the beginning of a slide toward recession. Given the zero lower bound, the Committee would be very preemptive and aggressive in this case. So, perhaps a zero rate is more likely than the next move being a rate hike. What do you think? 

Symmetry Defined in Practice 

While the Committee has not said so, they will act going forward as if symmetry means something different than in the past. In the past, it meant simply that policy would aim to bring inflation back to 2%, regardless of whether it started above or below 2% and how long it had deviated from its objective. Now, in practice,  the Committee will act differently, even if it hasn’t explicitly said so. Today, in practice, symmetry means at least some degree of makeup. That is, if inflation is below 2%—far enough below and for long enough–the  Committee would welcome, indeed aim for, inflation above 2% to offset the shortfall. That’s part of any makeup strategy. However, it’s possible that any official, explicit makeup strategy might only come into effect when the fund’s rate reaches the zero lower bound. 

Could a change in the meaning of a symmetric inflation objective come as early as January, when the Statement on Long run Goals and Monetary Policy and Strategy is up for its usual annual revision? The only previous substantive change was the introduction of the word “symmetric”! 

What’s a Material Change in the Outlook? 

This is the key question with respect to monetary policy, given the FOMC’s guidance. Always hard to identify this in terms of a single variable. We will consider growth, inflation, and inflation expectations. 

First, there is some growth rate below trend, as reflected in the incoming data and macro projections for the coming year, that would represent a material change. We expect growth close to 2% in the second half and close to that, maybe a touch lower, in 2020. While there’s uncertainty about the growth rates of both actual and potential output next year, we expect growth will be only slightly below potential at most. Growth a  couple tenths below potential would be worth a rise in the unemployment rate of a tenth at most, which the 

The committee seems willing to tolerate it. But let’s say that growth is just ¼ pp slower than that–the trend, not just one or two quarters. We see that as a material change! For example, growing closer to 1½% might mean a two- or three-tenths increase in the unemployment rate. A rise in the unemployment rate of that magnitude might be okay if it is projected to occur over several years, as the FOMC has been projecting. But if it occurs over a relatively short period, that would quickly raise concerns, as a rise in the unemployment rate of about  ½ percentage point in less than 12 months has been a reliable recession signal. In this case, it wouldn’t really matter if the rise was moving the unemployment rate back to the NAIRU from below. The FOMC would move. 

Second, there must be some inflation rate below 2% that would force the FOMC to ease if it stayed there long enough. A core inflation rate that fails to pick up next year, remaining several tenths below its objective,  as it has this year, combined with below-trend growth could be enough. 

Third, erosion of inflation expectations would make the FOMC act sooner and more aggressively to below-trend growth and inflation remaining below 2%. 

Would any of these alone be a material change in the outlook? A sharp change in the labor market certainly would be. As for growth, inflation, and inflation expectations, perhaps not. But together, they would add up to a material change. 

The Message in the Statement 

The message in the statement has to be consistent with the economy being in a good place, the outlook being favorable, and monetary policy thus being in a good place and likely to stay there, at least in the near term, unless there’s a material change. That is the narrative, though there’s no need to say that outright in the statement. Just can’t say anything that questions that. Fortunately for the FOMC, it appears that the incoming data since the last meeting won’t force any changes to the first paragraph, which lessens the chance of being misinterpreted. In our guess of the first paragraph, we show no change, though we think there will at least be some small tweak in the wording somewhere for the sake of a change. 

At the last meeting, they were looking at the September jobs report. We now have the October jobs report  (strong, but unemployment rate up a tenth to 3.6%) and will have the November report before next week’s meeting. Regardless of whether the unemployment rate stays at 3.6% or goes back down to 3.5%, “remains low” is likely to stay. With the October payrolls data has been quite good, barring a quite substantial surprise in the November data, “solid” is very likely to remain as the descriptor for the pace of job gains. 

We also have the revised Q3 GDP data, as well as some very preliminary monthly data for Q4. Q3 GDP was revised very little, so no changes needed on account of that. “Moderate” is still a good descriptor of the pace of growth of economic activity. As for other data, we’ve had positive surprises on trade, with the balance narrowing more than expected. Real consumer spending has cooled somewhat in recent months and grew only modestly in October. Housing still looks better. We had a nice beat for core capital goods orders and shipments in November, but structures still look poor. Overall, business fixed investment can undoubtedly  still be called “weak.”

So, yes, there have been some innovations in the incoming monthly spending data, but in our view not enough  to require a change to the language: “Although household spending has been rising at a strong pace, business  fixed investment and exports remain weak.” The recent trade data have been a notable development with respect to Q4, but the statement refers to “exports” being weak, and that continues to be true. The recent narrowing in the balance has been because of imports declining more than exports. 

If there were to be a substantive change in the first paragraph, perhaps the most likely change would be some reference to the apparent moderation in consumer spending in recent months entering the fourth quarter. But  the statement lumps together consumer spending with housing into the category of “household spending.”  Why add this nuance about moderating consumer spending now, when household spending is still driving the expansion and at the first meeting in some time at which the FOMC is not cutting rates? That’s color Powell can add in the press conference. 

As for the last couple of sentences, on inflation and inflation expectations, we expect no change. The recent  inflation data have been disappointingly soft, but the language in the statement is already about inflation  “running below 2 percent.” 

Changes are required to the second paragraph. Instead of justifying a cut, the language has to be consistent with the decision to remain where the Committee is. Given that the FOMC is pretty content at the moment with not only policy but also its messaging, there’s not much more to change. Any change gets scrutinized.  So leave well enough alone. 

However, there is a question as to what leaving well enough alone with respect to the guide means. In  particular, the justification for easing in the previous statement included references to “the implications of  global developments” and “muted inflation pressures.” Those two factors are absolutely still in play, so it’s very possible the FOMC will try to fit them in elsewhere. That might be seen as more consistent with the idea of maintaining the guidance that’s already out there, though it would also require revising more parts of the second paragraph. 

Our guess for the second paragraph (shown below) is intended to be what we see as the simplest option,  one that retains the key elements of the previous statement. We have them retaining references to “the  implications of global developments” and “muted inflation pressures.” Since those references had been in the sentence explaining the decision to ease, we have them being moved later in that paragraph. In our guess,  we have them joining another part of the guidance that still holds and that we expect to be retained:  “uncertainties about this outlook remain.” 

We don’t expect any dissents at next week’s FOMC meeting, consistent with FOMC participants being far more satisfied with the current positioning of policy than they have been for some time. 

Plenty of Time to Talk about the Review 

Not much to say about the outlook. Not much to say about policy. But a lot of discussions this meeting and in the following meetings will be about the Review. After this meeting, there may be only a few more meetings 

of discussion before any revisions announced mid-2020, which the Committee has said is the most likely time for an announcement of revisions to the policy framework. In our commentary on the recent Brainard talk,  we surmised that the Committee, really the subcommittee, might be closer than we thought to recommendations on revisions to the policy framework. Along the way, discussions among policymakers at  FOMC meetings have been moving along the way toward a consensus. The revisions could be substantial, in which the Committee could likely want very widespread buy-in. That could delay the decision. On the other hand, the Committee should be sensitive that, given the downside risks, they could be at the zero lower bound sooner rather than later, in which case they would want to have a new policy framework ready to go. 

Balance Sheet Policy 

The schedule of reserve management purchases (of Treasury bills) and repo operations is being handled by the New York Fed on a separate schedule from the regular FOMC meeting cycle. Thus, while the FOMC will likely deliberate on the progress and future plans for these measures, we don’t expect any announcement at this meeting. As this is the last meeting of 2019, special attention will be paid to year-end pressures. An  IOER adjustment at this meeting is not likely.

Our Guess of The Statement 

Information received since the Federal Open Market Committee met in October September indicates that the labor market remains strong and that economic activity has been rising at a moderate rate. Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending has been rising at a strong pace, business fixed investment and exports remain weak. On a 12- 

month basis, overall inflation, and inflation for items other than food and energy are running below 2 percent.  Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed. 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 1-1/2 to 1-3/4 percent. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 1-1/2 to 1-3/4 percent. The Committee continues to view This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the  Committee’s symmetric 2 percent objective as are the most likely outcomes, but uncertainties about this outlook remain. However, uncertainties about this outlook remain, in part because of the implications of global developments, and inflation pressures remain muted. The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate. 

In determining the timing and size of future adjustments to the target range for the federal funds rate, the  Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice-Chair; Michelle  W. Bowman; Lael Brainard; James Bullard; Richard H. Clarida; Charles L. Evans; Esther L. George; and Randal  K. Quarles; and Eric S. Rosengren. . Voting against this action were: Esther L. George and Eric S. Rosengren, who preferred at this meeting to maintain the target range at 1-3/4 percent to 2 percent.

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