March Dots Move Down Sharply, Consistent With Our No-Hike Call

FOMC participants’ projections indicate that they see the outlook as having deteriorated meaningfully since they last submitted projections, in December. The median dots now show only one hike, rather than three,  with that lone hike in 2020; the median shows no hike this year. We see this as consistent with our call of no more hikes, as we see no rational grounds for projecting a rate hike in 2020 when there are no hikes in  2019. 

We thought the FOMC would make an announcement on the balance sheet at this meeting, and they gave even more specifics than we’d expected. Their plans are broadly in line with what we’d expected. In particular,  they took the more conservative approach under consideration: stopping runoff earlier, then letting reserves  gradually decline via growth in non-reserve liabilities toward “the level of reserves necessary to efficiently and  effectively implement monetary policy.” Today’s announcement didn’t mention a repo facility, though discussions likely continued at this meeting. 

The Macro Projections and the Dots: What Did They Do and Why? 

FOMC participants made meaningful downward revisions to their growth projections and upward revisions to their unemployment rate projections even as they lowered the projected path of the fund’s rate. Core inflation continued to be projected at 2% through 2021, however. We always emphasize that the dots and the forecast go together and that you can’t fully understand one without the other. First, we summarize the macro and rate projections. Then we put the two together and assess how they are connected. 

The macro projections through 2021 

▪ Participants revised down growth by two tenths in 2019 and a tenth in 2020. Growth in 2021 was  unchanged. 

▪ They marked up the path of the unemployment rate, by two tenths in 2019 and 2020 and a tenth in  2021. They now expect only a very slight further decline in the unemployment rate, followed by a  more gradual rise. 

▪ This reflects both a higher jumpoff for the unemployment rate and weaker projected growth.  ▪ The projections for core PCE inflation were unchanged: 2% in 2019, 2020, and 2021. 

The Stars 

▪ As we expected, they revised down their estimate of the longer-run unemployment rate, from 4.4%  to 4.3%. 

▪ There was no change in the projection of longer-run growth (1.9%). 

▪ The median longer-run funds rate projection remained at 2.75%. We had thought this might fall. We think there is a bias to a slight further decline in the estimate of nominal r-star. 

The Dots: What are they thinking showing a hike in 2020? 

▪ The median dots now show only one more rate hike, down from three in December. That’s as  expected. 

▪ We thought there might be some inertia, so they would leave in one hike in 2019 (down from two in  December). Instead, they took out both 2019 hikes and left the one hike in 2020. 

▪ I have to admit, we did talk about where to put it. But, speaking for myself, I cannot understand how they could take out all hikes in 2019 and leave one in 2020.

         Projections of inflation and growth in 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. 

Connecting the Dots, With (Only a Little) Help From Powell 

The December projections showed three more rate hikes. Early in 2019, it became clear there would be a  pause in rate hikes. But the plan to pause in March was explained, understandably, in terms of risk management. At his January press conference, Powell said there had not been any big change in the baseline outlook, though he hinted that perhaps that was in part because FOMC participants had marked down their assumptions for policy tightening. It’s clear that the FOMC became more pessimistic about the baseline outlook since then. They marked down the baseline outlook meaningfully in their March projections despite projecting only one further rate hike, two fewer than in December, and not marking down r-star significantly. 

Powell explained the downward revisions to the growth outlook by citing three things: financial conditions,  the incoming U.S. economic data, and a slowing in growth outside the U.S. Powell downplayed the substantial easing in financial conditions that have taken place in recent months. Rather, Powell reiterated in his prepared  remarks that financial conditions “tightened considerably over the fourth quarter.” He acknowledged that  “conditions have eased since then,” but he maintained that “they remain less supportive of growth than  during most of 2018.” 

He pointed to a few specific areas of the U.S. economic data in 2019 that have been “somewhat more  mixed.” He noted that “Unusually strong payroll job growth in January was followed by little growth at all in  February.” The trend in job growth “appears to have stepped down from last year’s strong pace.” The recent  retail sales data “seem to point to somewhat slower growth in consumer spending.” He also noted that business fixed investment seems to have slowed relative to last year. The FOMC isn’t just entirely looking through the projected weakness in Q1 growth, despite the government shutdown contributing in part to that weakness. 

In response to the downgrade in the growth outlook, participants took out two hikes in 2019. But that was,  understandably, not enough to completely offset the expectation of weaker growth this year. The downgrade  to the outlook was apparently substantial enough, however, for 2020 to be marked down a bit as well, and 

for 2021 to be unchanged despite the lower projected path of the fund’s rate. That’s even more striking since they didn’t mark down the longer-run dots as much as we’d anticipated. They now have the fund’s rate remaining below its longer-run level through 2021 and, despite that, expect growth to fall below potential and the unemployment rate to rise. 

All of the quotes above were from Powell’s prepared remarks, and we didn’t get much more explanation of the outlook than that in his press briefing. He reiterated, over and over, that “the reason we’re on hold is that we think our policy rate’s in a good place. And we think the economy’s in a good place. And we’re watching carefully, as we see these events evolve around the world and at home. And we think that’s what we need to be doing.” In effect, the policy is neutral, symmetric. The next “adjustment” could be up or down. Good,  consistent with no hike this year. But why, early in 2019, is there “tightening bias” for 2020? Do you know something we don’t about 2020? You seem to have an obsession with a hike in 2020. Why? 

The Press Conference 

There was remarkably little in this press conference, so mainly we refer to his relevant comments in various places elsewhere in this piece. Powell did emphasize, when asked, that faster wage growth “does not trouble  me from the standpoint of inflation” and noted that, “in other cycles, we’ve had situations where, you know,  unit labor costs were moving up above inflation and that didn’t lead to price inflation.” Nothing new there,  but it seems relevant given the apparent increased focus recently by some in the market on the potential that wage inflation will pass through to higher price inflation. 

I, of course, was hoping Powell would explain the lonely hike in 2020. He was given the opportunity in the last question. In effect, what would cause you to raise rates in the future? He sidestepped that, perhaps because he didn’t want to explain why participants did in fact expect a hike in the future. 

Balance Sheet 

We thought the FOMC would make an announcement on the balance sheet at this meeting, and they gave even more specifics than we’d expected. Their plans are broadly in line with what we’d expected. In particular,  they took the more conservative approach under consideration: stopping runoff earlier, then letting reserves gradually decline toward the minimum necessary level through the growth of non-reserve liabilities. 

The portfolio will stop declining after September 2019, which is perhaps a bit on the earlier side of market expectations. In response to a question at his press conference, Powell elaborated that the balance sheet will likely be “a bit above 3.5 trillion” at that point. The monthly runoff of Treasuries will be reduced beginning in May,  from a maximum of $30b to $15b, and will cease after September 2019. This is a basic “taper,” which we didn’t think they do. Runoff of agency debt and MBS will continue indefinitely, with amounts over the $20b  cap reinvested into agency MBS. The FOMC reaffirmed its view “that limited sales of agency MBS might be  warranted in the long run to reduce or eliminate residual holdings.” That is in line with our long-held expectations. Through September, principal from agency securities below the cap will continue to be allowed to run off. After September 2019, principal payments below that cap will be invested in Treasury securities,  with these purchases across maturities roughly matching the maturity composition of Treasury securities outstanding. At the end of September 2019, reserves are expected to still be greater than necessary. While the size of the portfolio will remain constant for some time after that, reserves will continue to decline as currency and other non-reserve liabilities grow. Eventually, when reserves are deemed to have reached the minimum necessary level, securities holdings will be increased to maintain a sufficient level of reserves.  

The FOMC announced many decisions today, but still has some decisions to make in the future. The big decision now is when and how to begin increasing the size of the balance and what the ultimate composition of the Fed’s securities holdings will be. In his press conference, Powell called the latter “the next big one, the 

next big decisions that we’ll face,” adding, “I think we’re not going to be in a rush to resolve it. But we’ll turn  to it soon.” We have assumed that, in the end, they will try to align the maturity distribution of the Fed’s  Treasury holdings with that of all outstanding Treasuries, though there are other plausible alternatives. There was also no announcement related to a possible repo facility. We expect the minutes of this FOMC meeting to describe the continued discussion of such a facility.  

Here is a breakdown of the Fed’s announced balance sheet policy for the months ahead: Policy through April 2019 (no change) 

Total runoff capped at $50b per month 

Runoff of Treasuries 

-capped at $30b 

-amount over $30b rolled over into Treasuries at auction 

Runoff of agency debt and MBS 

-capped at $20b 

-amount over $20b reinvested into agency MBS 

Policy from May 2019 through September 2019 

Total runoff capped at $35b per month 

Runoff of Treasuries 

-capped at $15b 

-amount over $15b rolled over into Treasuries at auction 

Runoff of agency debt and MBS (no change) 

-capped at $20b 

-amount over $20b reinvested into agency MBS 

Policy beginning in October 2019 (assuming reserves still greater than necessary) 

Size of portfolio held “roughly constant for a time” 

No runoff of Treasuries 

full amount of principal payments rolled over into Treasuries at auction 

Runoff of agency debt and MBS 

-capped at $20b (no change) 

-amount over $20b reinvested into agency MBS (no change) 

amount up to the $20b cap invested in Treasury securities to “roughly match the maturity  composition of Treasury securities outstanding”

Statement 

The statement, as we had expected, was the least interesting event of the day, maybe challenged by the press conference. In any case, changes to the March FOMC statement were all in the first paragraph, which describes the incoming data, and the sentiment, if not the wording, was about in line with our expectations!  They acknowledged the apparent slowing both in overall economic activity overall and in the sectors specifically referenced in the statement (household spending and business fixed investment) without attempting to downplay it or explain it away. The changes were on the dovish side, though they by no means indicated alarm. They were consistent with the weaker outlook apparent in FOMC participants’ rate and macro projections. 

They downgraded the language in the first sentence on the pace of growth to acknowledge the apparent first-quarter weakness. Rather than say “economic activity has been rising at a solid rate,” they said, “growth of  economic activity has slowed from its solid rate in the fourth quarter.” Similarly, they said, “Recent indicators  point to slower growth of household spending and business fixed investment in the first quarter.” These are simple, clear downgrades in line with the incoming data. 

They changed the language of the labor market in a dovish direction. But while the labor market language was downgraded, they were clear that they see the labor market as strong. In the first sentence, rather than  saying the “labor market has continued to strengthen,” they said it “remains strong.” They gave a specific  nod to the weak February payroll print, noting “payroll employment was little changed in February,” but then  adding the qualifier that job gains have been “solid, on average, in recent months.” The latter description,  “solid,” was a downgrade from “strong.” This was an interesting change since three- and six-month average payroll gains remain above 180K, and in the recent past, they’ve used “strong” when that’s been the case. 

They chose to acknowledge the dip in 12-month headline PCE inflation, saying “overall inflation has declined,  largely as a result of lower energy prices,” while the 12-month core still remains “near” 2%. They noted that “On balance, market-based measures of inflation compensation have remained low in recent months, and  survey-based measures of longer-term inflation expectations are little changed.” The “on balance” could be a  nod to the modest firming in the five-year, five-year forward breakeven inflation rate since early January or the dip in the Michigan measure of longer-term inflation expectations to 2.3% before it rebounded to 2.5%. 

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