Nothing in November!

Obviously, there will be no policy action in November. 

▪ It’s a so-called off meeting (no press conference), and of course that matters. 

▪ In any case, it is appropriate to be in a wait-and-see mode, waiting to see if the incoming data between the November and December meetings clarify the inflation picture. 

The deliberation in November is about December. 

▪ Of course, that has to be the case since the November decision and statement have already been decided. ▪ But the outlook poses remarkable challenges. First is how to reconcile persistently low core inflation with the very low and still-declining unemployment rate. Does this mean the Phillips curve is entirely unreliable or just that it’s very flat? 

▪ And what is the balance of risks with respect to inflation and the unemployment rate? Are the risks to the inflation outlook tilted toward the downside? Surely yes, in the near term. But could the greater medium-term risk be inflation overshooting 2%?  

▪ With respect to the unemployment rate, are the risks tilted to a lower unemployment rate than the FOMC  projects? We think so. 

To signal a December hike or not? 

▪ As we emphasize, the statement, as well as the minutes, are of course scrutinized for signals about upcoming decisions. 

▪ Don’t expect any signal in next week’s statement. The minutes will be more interesting. 

The Outlook Context 

There are two considerations with respect to the data and the forecast that are pushing monetary policy in opposite directions. The first is that there has been an unexpected and mostly unexplained slowing in core inflation, with the 12-month core PCE inflation rate falling from 1.9% in February to 1.3% today. That counsels caution, patience, a wait-and-see approach until the data clarify the picture. The second is that the unemployment rate has already fallen below the NAIRU and, given projected above-trend growth through 2019,  is expected to fall further. That suggests: Keep going.  

Where is Underlying Inflation?  

The mystery today is the source of the sharp slowing in core inflation since February. In February, the 12- month core PCE inflation rate was 1.9%. The 12-month rate is usually seen as a good measure of underlying inflation, as it smooths over a good deal of month-to-month noise. In early 2017, the FOMC seemed to have virtually achieved its inflation objective. Indeed, that’s why participants’ median projection for inflation in  2018 was 2%. But today, at 1.3%, 12-month core PCE inflation is the lowest it’s been since 2015 when core inflation had slowed following a material appreciation of the dollar. 

The question is whether this slowing is transitory–so the underlying inflation rate is closer to 1.8% or 1.9%- -or more persistent–consistent, perhaps, with an underlying inflation rate closer to 1.5% or even lower. That’s like night and day. The consensus on the FOMC is for the first explanation, but some worry a lot about the latter. Many described themselves as in a wait-and-see posture, awaiting more data to clarify the situation.  But it may be well into 2018 before the incoming data provide any clarity. 

We take some signal from the slowing in core and the fact that the Dallas Fed trimmed-mean inflation rate,  another measure of underlying inflation, has declined from 1.9% to 1.6%. This measure is especially useful when there have been shocks to particular components. In any case, we lowered our forecast for 2018 by two tenths to 1.8% a while ago, while FOMC participants lowered theirs just a tenth to 1.9%. 

Improving or Overheating 

We keep on saying that the labor market is improving, pointing to solid payroll employment growth, well above a rate consistent with a stable unemployment rate. And, consistent with this, there’s been a steady decline in the unemployment rate. It’s already ½ percentage point below the median estimate of the NAIRU,  and we expect it to fall another ½ percentage point. 

Is that good or bad? Should we take comfort that the labor market is still improving or begin to focus on the degree to which it may be overheating? Good when inflation is well below the 2% objective, as it is now, but worrisome once inflation rises to its objective. At this point, wage inflation has given us little indication of overheating in the labor market. 

A Bit More Momentum in GDP: Too Much of a Good Thing? 

We revised our forecast for growth slightly higher recently, seeing a bit more momentum and taking into account a further easing in financial conditions. That easing, or rather a lack of tightening, is pushing the  FOMC to continue to move. 

We project faster growth than FOMC participants’ median projection, presumably in part because we assume a fiscal package is passed in mid-2018, whereas fewer and fewer participants expect any fiscal stimulus. But the key here is that growth is expected to be above trend, at least through 2018, pushing the unemployment rate still lower.

Fiscal Stimulus: Boosting Demand at the Wrong Time 

A key question is whether fiscal stimulus is more of a demand or supply event. Would its main impact  (especially over the FOMC’s policy horizon) be to increase demand, rather than raise potential output? We and the FOMC assume the former. Given that growth would likely continue at an above-trend rate and the unemployment rate would likely continue falling further below the NAIRU even without fiscal stimulus, the  FOMC sees any fiscal expansion as poorly timed. That means they will have to raise rates faster and perhaps overshoot the neutral rate, which itself could move up more than expected. 

Financial Conditions and Monetary Policy 

Apparently, it’s not so easy to withdraw accommodation. Withdrawing accommodation means making broader financial conditions less accommodative–higher private rates, lower equity prices, a stronger dollar– not just a higher funds rate. There’s the rub. It’s not happening! The fund’s rate is already rising and the  Committee is communicating that they plan to raise the fund’s rate further. Yet financial conditions have become more accommodative. Another conundrum. Has the FOMC lost control? Not likely, but it may have to work harder, which means there could be a risk of a faster and further rise in the fund’s rate.  

FOMC Call 

Nothing in November. Of course not, since it’s an off meeting! The meeting should be dominated by participants’ discussion of two questions: First, what accounts for core PCE inflation has slowed dramatically, from a 12-month rate on the edge of the 2% objective back to levels last seen in 2015? The consensus is that this is a transitory slowdown and doesn’t signal a material slowing in the underlying inflation rate. The policy question is to what degree the Committee should be in a wait-and-see posture, waiting for the incoming data to clarify the inflation picture. Second, how should it recognize that the unemployment rate fell more quickly than projected and how concerned should the FOMC be that the unemployment rate is already ½ percentage point below the median estimate of the NAIRU and projected to fall even further?  

Nothing But Talk in November 

There has been a disconnect between the continuing decline in the unemployment rate–now to a level well below the median estimate of the NAIRU–and persistently low core PCE inflation. That has led to a revival of the split between the data-dependent (show me the inflation) camp and the forecast-based camp. These questions will be settled, but it may take some time. At this meeting, the discussion of the outlook is likely to be dominated once again by questions of why core has slowed so sharply, why many believe the sharp slowing in core inflation is transitory, whether it signals a lower underlying inflation rate, and how much weight the Committee should place on a Phillips-curve-based inflation forecast. This is all preparation for the  December decision. 

Looking Ahead: December is a Go 

The Committee does not explicitly talk about the next meeting. But all the discussion is essentially about that since everyone already knows what the November decision is. Indeed, the Committee is focusing on the issues that will shape the decision at the next meeting. The discussion at this meeting, as reported in the minutes,  will provide additional information for assessing the probability of a December hike. We could also get immediate help on Wednesday if the statement offers a signal of where the Committee is leaning. Not likely,  though we believe there is still a strong consensus in favor of a hike in December, as reflected in the  September dots.

Monetary Policy and the New Chair 

The nominee to be the next Chair may already be named by next Wednesday. The current buzz is that,  consistent with our own expectations, it will be Powell. That’s good because it means continuity in policy! 

Message from the Statement 

We suspect the Committee is more than satisfied with markets substantially pricing in a December hike. So the mission is: Don’t rock the boat. This principle applies to the first paragraph, on the state of the economy,  where the Committee sets out what has changed since the last meeting, and it is often the only guidance about upcoming policy. The language on both inflation and the labor markets is important, but the inflation language is most important. The labor market will be characterized as having improved, which it has, though the FOMC will have to acknowledge the decline in job gains and explain that it is seen as an effect of the recent hurricanes and expected to be reversed in coming months. The second paragraph is forward-looking and likely to be unchanged.  

We don’t expect a change in the balance-of-risks sentence. But it seems to us that, in the near term, the balance of risks with respect to inflation is clearly to the downside, and the balance of risks with respect to participants’ projections of growth are to the upside. 

Our Guess of the Statement 

Information received since the Federal Open Market Committee met in September July indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. The number of jobs declined in September, but that was likely because of the temporary effects of recent hurricanes, and the decline is likely to be reversed in the coming months. Overall, the trend in job gains has Job gains have remained solid in recent months, and the unemployment rate has stayed low declined.  Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed,  on balance. 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship.  Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation Inflation on a 12-month  basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the  Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely. 

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

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 objectives of maximum employment and 2 percent inflation. 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate;  the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data. 

In October, the Committee will initiate continue to implement the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans. 

Voting for the FOMC monetary policy action was: Janet L. Yellen, Chair; William C. Dudley, Vice  Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari;  and Jerome H. Powell; and Randal K. Quarles. 

Market Response 

Expectations of a December hike are unlikely to move on the release of the FOMC statement. A December hike is currently priced in. If the inflation language is more dovish than anticipated, then there could be some pullback in rate-hike expectations. The market is more focused on the imminent Fed Chair nomination. 

Dissents 

We expect no dissents at this meeting.

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