What a remarkable intermeeting period for FOMC communications. Public remarks by FOMC participants since the January FOMC meeting demonstrated how unofficial communications can shape market expectations of monetary policy. At first, we expected the next hike to come in June. Then, somewhat more favorable economic data and policymakers’ reactions suggested a greater probability of an earlier hike, leading us to change our call to May, with a sizable probability of a March hike. Finally, in the week leading up to the communication blackout period ahead of the March FOMC, in a series of apparently orchestrated communications, FOMC participants all but announced that there would be a rate hike at this week’s meeting. The decision to hike in March appears to be motivated by a perception of diminished downside risks and a strong desire to get back to the “gradual” pace of rate hikes that have long been the FOMC’s “plan.” There has been little to suggest a material change in the economic outlook since the December 2016 FOMC meeting, when FOMC participants last submitted economic and funds rate projections, and the consensus still appears to be at three hikes in 2017, but with risks now weighted toward four or more, rather than two or fewer.
The employment report for January, released shortly after the January FOMC meeting, was quite strong. Speaking after that report, President Evans was one of the first FOMC participants to indicate a change in sentiment. Whereas he’d been at two hikes in December, he said that “the way things are going, I could see three hikes. I could be comfortable with that.” However, he was still concerned about downside risks, and he said, “I think you need to see progress on inflation” before raising rates further. Chair Yellen’s mid-February monetary policy testimony also showed a slightly hawkish change in tone. She noted that “waiting too long to remove accommodation would be unwise,” and also said that, “At our upcoming meetings, the Committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” Previously, she had tended to emphasize more the risks of tightening policy too early or too quickly.
However, well into February, even with some participants’ comments seeming a bit more hawkish than before and the prospects for an earlier hike having improved, the probability of a March hike was still seen as less than 50 percent by both us and the market. At her testimony, Chair Yellen, understandably, had refused to comment specifically on the timing of the next move: “Precisely when we would take an action, whether it’s March or May or June…I can’t tell you exactly which meeting it would be. I would say that every meeting is live.” President Lockhart, whose comments are often informative as to where the consensus is headed, didn’t “feel there is a great deal of urgency” for rate hikes and didn’t “see really compelling reasons to move ahead in March.” He saw two or three hikes as appropriate in 2017, and “felt it was too early” to factor fiscal stimulus into his forecast. Similarly, President Dudley said, “it’s really hard to factor [fiscal policy] into your forecast at this point.” On rate hikes, he said only that the FOMC would expect to “snug up interest rates a little further, in the months ahead.” Board Vice-Chair Fischer described the economy as “more or less on the path” of its projections, assuming further progress on both inflation and employment, hardly a statement that would build expectations of a March hike.
The January minutes—which caused a bit of a stir by revealing that “many” participants thought “it might be appropriate to raise the funds rate again fairly soon” if the data came in as expected or better than expected—seemed to us to suggest no greater likelihood of a March hike than the data and participants’
public remarks had already indicated. President Lockhart seemed to shift slightly on a March hike when he said that “the data are supportive of considering a move.” But he downplayed the “fairly soon” language from the minutes, saying that he interpreted that as referring to the next three meetings, and he continued to point to two or three hikes in 2017. At this point, Governor Powell also did not take the opportunity to build expectations of a March hike, confirming, only when asked, that a March hike was on the table and saying that three hikes in 2017 seemed plausible.
Then came the final week before the communication blackout period. Before that, many policymakers had said that a March hike would be on the table, but markets remained skeptical; after all, participants always say every meeting is live. Five of the most prominent FOMC members—Dudley, Brainard, Powell, Fischer, and Yellen—then spoke on separate occasions, increasing the prospects of a March hike to a near certainty. President Dudley went first, and we moved our call for the next rate hike to March after he spoke. Whereas previously he had been one of the prominent advocates on the FOMC of a patient approach to raising rates in light of downside risks, he now said “we’re very much on the trajectory…that we thought we’d be on” and developments “should make us even more confident that this is going to continue in the future.” He saw risks “now starting to tilt to the upside.” He concluded that “the case for monetary policy tightening has become a lot more compelling.” Governor Powell delivered a similar message: “I think the case for a rate increase in March has come together.” Governor Brainard remarked that “Assuming continued progress, it will likely be appropriate soon to remove additional accommodation”—less emphatic than Dudley, but significant considering that she had long leaned against raising rates. On Friday, Chair Yellen removed any doubt about the FOMC’s inclination to hike in March: “At our meeting later this month, the committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” Finally, Board Vice-Chair Fischer reinforced that message, saying “if there has been a conscious effort to put March on the table, I’m going to join it.”
While the evolution of FOMC participants’ views regarding a March hike was clearly the dominant narrative in policymakers’ remarks since the January FOMC meeting, other important themes emerged. One is that policymakers did not seem to mark up their macro forecasts or funds rate projections meaningfully, even though policymakers clearly saw diminished downside risks to the outlook. Policymakers continued to see significant uncertainty, especially related to fiscal policy. While Bullard argued that the FOMC might be better off waiting to raise rates until there was more clarity on fiscal policy, he was clearly out of the consensus. Some argued that the economic outlook, even assuming no fiscal stimulus, warranted gradually raising rates, while others incorporated assumptions of fiscal stimulus into their baseline outlooks or spoke of fiscal stimulus as shifting the balance of risks to the upside. Notwithstanding the increased confidence in the outlook, there still seemed to be a clear consensus for three rate hikes in 2017. Indeed, even as she indicated that the FOMC would hike in March, earlier than previously suggested, Chair Yellen still pointed to the median pace of three hikes from the December dots as consistent with the “gradual pace” referenced in FOMC statements.
Balance sheet policy remained a recurring topic for policymakers, and while no consensus has emerged, the general trend has been toward an earlier end to the current reinvestment policy. President Bullard argued for an earlier start: “We should be allowing the balance sheet to normalize naturally now, during relatively good times, in case we are forced to resort to balancing sheet policy in a future downturn.” On when to alter the
reinvestment policy, President Williams said, “We’re not there yet,” but suggested that three or four funds rate hikes this year would qualify as funds rate normalization being “well underway.” Chair Yellen told members of Congress that the Fed would reach a “substantially smaller” balance sheet in an “orderly and predictable way.” She also noted that she did not see the balance sheet as an “active tool” and that the FOMC does not plan to rely on balance sheet policy “frequently” in the future.