Upgrade on Growth, Hint of More Confidence on Inflation

The statement was hawkish, but not unexpectedly or dramatically so. First, the FOMC described gains in  household spending and business fixed investment as “solid.” For household spending, this was an upgrade  from “expanding at a moderate rate.” In the previous statement, there was a reference to business fixed  investment has “picked up in recent quarters.” Second, it recognized that market-based measures of  inflation compensation “have increased in recent months but remain low.”  

Most importantly, the Committee no longer said inflation on a 12-month basis was “expected to remain somewhat below 2 percent in the near term,” a fixture of recent statements. Instead, the statement says that  inflation is “expected to move up this year.” At first glance, this revision appeared to be a signal of a shift in focus away from acknowledging that inflation may continue to be soft in the near term and toward a view that inflation is firming, providing more confidence in the forecast of inflation moving to 2%. The FOMC could well like that interpretation, but there is likely another reason for changing the language: The data made them do it! Whereas in the first paragraph both core and “overall” inflation are specified, the word “inflation” in the second paragraph is vague. However, it certainly includes headline inflation, and the 12-month PCE inflation rate has actually moved up and was 1.8% in November and 1.7% in December. And with oil prices having  moved up further, the FOMC likely didn’t feel comfortable saying the 12-month rate was likely to remain  “somewhat below 2 percent in the near term.”  

There was a question as to whether they would modify their assessment that near-term risks to the economic outlook appear “roughly balanced,” since risks do seem to have shifted to the upside. However, as we expected, they didn’t modify this language; it was too soon to say it in the statement. But we bet they talked about it.  

There was one other change in the language, one that is difficult to interpret but appears, if anything, to be a minor hawkish change. In two forward-looking parts of the statement, the qualifier “further” was added before mentions of prospective tightening actions: In the second paragraph, the statement noted that with  “further gradual adjustments in the stance of monetary policy,” growth would remain moderate and the labor market would remain strong. In the fourth paragraph, the FOMC now expects conditions will evolve to warrant  “further gradual increases in the federal funds rate.” While this change will get lots of attention, we don’t suggest reading too much into it. For one, this language has shown up in other communications from the last few meetings, for example, the SEP and the minutes. It could be that the addition of the qualifier “further”  suggests that the FOMC sees slightly more urgency to maintain a gradual pace of hikes to preempt overheating risks. But this would be a confusing, and unnecessary, way to signal that. 

All in all, the statement did not have any effect on our conviction in a March hike or our call that there will be four hikes this year. It was very consistent with the view that four hikes are much more likely than two and that the Committee is thinking three or four hikes, and already on their way to a consensus for four. 

The FOMC also reaffirmed its Statement on Longer-Run Goals and Monetary Policy Strategy. As expected,  the only change was to update the reference to FOMC participants’ median estimate of the NAIRU.

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