In recent weeks a very strong consensus had formed that the economy was on track, with the labor market essentially at full employment and price stability appearing to be in reach. Almost all FOMC participants agreed that a gradual pace of rate hikes was appropriate. FOMC participants appear inclined to look through the apparently weak Q1 growth, consistent with what we see as a lower inclination to deviate from this gradual pace of hikes in response to developments expected to prove transitory. On the other hand, it will be interesting to see how FOMC participants react in the coming days to the very soft CPI report for March. A soft report on core PCE inflation in a couple weeks could well wipe away any sign of progress toward the 2% objective over the last year or more. We nevertheless continue to expect two more moves this year, the next coming in June.
Policymaker Communications
Randal Quarles is reportedly likely to be announced as President Trump’s first nominee to the Federal Reserve Board; see our recent commentary for our take on this development [link].
A couple FOMC participants began to comment more explicitly on the interactions between forthcoming balance sheet reduction and rate hikes. Bullard argued that the current combination of rate hikes and expected change in reinvestment policy results in a “twist” effect on the yield curve: “We’re raising the policy rate, which is raising interest rates at the short end of the maturity structure. But then, according to our own rhetoric, the big balance sheet is putting downward pressure on other parts of the yield curve…So you’ve really got this twist going on on the yield curve.” On the other hand, Kaplan was of the view that plans for the balance sheet would not have an effect on his rate hike views: “I’m not going to get into the pause, no pause. I think it’s more appropriate to talk about the path of rates…The objective and the initiative to let the balance sheet run off does not alter my views as to what the path of rates should be.”
The upcoming pace of rate hikes continued to be on policymakers’ minds. Bullard, who we previously thought only wanted to see one hike in total this year, revealed: “I could probably be persuaded to make one move or so…But I think the biggest issue is, what is the path over the next two years or three years? Is this a situation where we really have to get the policy rate, let’s say, 200 basis points higher from where it is today? And I don’t see that kind of urgency here.” Kaplan argued that the economy is not unambiguously strong (“[the economy] isn’t running away”), so the Fed “ought to be gradual and patient.” Williams’ sentiment was similar: “There is no indication that the economy is overheating or that inflation is picking up too much. My goal is to make sure that this doesn’t happen…I don’t think that we at the Fed are behind the curve. I think we are on the right track.” He saw three or four hikes in total this year: “Three to four interest rate hikes seem appropriate this year. If the economy is performing better than expected and if there is more growth or inflation, there can be four rate hikes…We need to further raise our benchmark interest rate and bring it back to a normal level over this year and next year, and we should also begin to normalize our balance sheet towards the end of this year.”
Yellen’s appearance before students in Michigan was focused more on the general aspects of monetary policymaking. She characterized the current optimal policy stance as “neutral.” She added, “whereas before, we had to press down on the gas peddle trying to give the economy all of the oomph that we possibly could, [we are now going to] give it some gas but not so much that we’re pushing down hard on the accelerator.” If the economy progresses as expected, the FOMC thinks “it’s appropriate to gradually raise the federal funds rate toward a more neutral stance.” She pointed to low productivity growth as an ongoing problem: “2 percent growth, which isn’t stunning in absolute terms, has generated a lot of jobs. But the fact that you could create that many jobs in the context of growth that is so low points to a significant problem…that productivity growth is very low.” She saw potential growth as likely being a little below 2%. She also reiterated her opposition to “audit the Fed” legislation, noting that mandating that the Fed follow a policy rule “goes even further in interfering with monetary policy independence.”