March Hike the First of Three This Year

The FOMC will raise rates in March. We know because they told us so! (link) 

▪ This illustrated in a dramatic way how speeches heading into an upcoming FOMC meeting provide guidance about the likely outcome at that meeting. Of course, it helps when Yellen tells us herself! ▪ We continue to expect three hikes this year, but the probability of four has increased. ▪ We expect the end of reinvestments (likely to be tapered) to begin early in 2018. 

The guidance has been that the timing of the next move depends on realized and expected progress toward the dual mandate. Has there been progress since the December meeting? 

▪ There has not been much further “realized” progress toward the dual mandate. The improvement has been significant over a longer period of time, but not since December. Indeed, there has been very little improvement in the unemployment rate and core inflation this year. 

▪ If it is expected progress that has changed, that would suggest the possibility of revisions in the macro projections or—more likely—in the rate paths. 

Instead of being motivated by progress toward the dual mandate, the March move signals the return to gradualism, a slow and continuous process. 

▪ Take a signal from the fact that the FOMC, for the first time in this tightening cycle, will have hiked back to back, that is, at consecutive meetings with pre-scheduled press conferences. ▪ The FOMC is now more forecast-based, rather than being seemingly only data-dependent. The data tell participants how close they are to achieving the dual mandate; the forecast informs what policy is appropriate to meet the Committee’s objectives in the future. 

▪ We expect three hikes to be the median pace in the March dots, as it was in December. Those participants who see three hikes as appropriate this year and see four as more likely than three likely prefer a March hike. Of course, it is more pressing for those who believe four or more hikes will be appropriate. 

▪ In addition, proximity to the zero bound has been a powerful force supporting caution. Now the other side, waiting too long and getting behind curve, has become a more pressing concern. 

A return to gradualism brings forward the timing of the end of reinvestment, a point when rate  normalization is “well underway.”  

▪ We assume the end of the current reinvestment policy will begin early next year. ▪ The Committee will have to begin to place more emphasis on the implications of changes in balance sheet policy for the path of the fund’s rate. 

▪ We raised the pace of increase in the ten-year term premium slightly to reflect an earlier projected end to reinvestments. 

A March Hike, the First of Three in 2017 

The first of the three hikes this year will come in March, of course. We expect there to be an even stronger consensus for three hikes (implied by the median year-end projected funds rate) than in December, perhaps nine participants, with more of the others expecting more than three hikes than fewer than three.

Participants’ talks and interviews during the week before blackout raised the market-implied probability of a March hike from 50% or lower to essentially 100%. That’s successful communication, undoubtedly orchestrated in this case! 

Reinvestment Policy and Term Premia 

The ten-year term premium rose substantially after the election, and we project a gradual further rise. We revised up the path of the term premium just a few basis points in this forecast, a revision that reflected our assumption that reinvestment would be phased out beginning early in 2018, rather than in the middle of the year. 

There was little change to the path of the ten-year Treasury yield in this forecast, other than the small revision to the term premium. We project that the ten-year yield will end this year at 2.75%, next year at 3.04%, and 2019 at 3.39%. 

Major Economic Indicators 

By default, values represent seasonally-adjusted, annualized growth rates (%) for the series indicated n the leftmost column. 

Note on Units and Transformations 

“Quarterly” values are q/q rates; “Annual” values are q4/q4 rates. For series followed by units in parentheses, “Quarterly” values are quarterly averages, and “Annual” values are q4 averages. 

* “Quarterly” values are not compounded to annual rates.

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