A quarter-point increase in the benchmark Fed funds rate, to 2.00%-2.25% has long since been priced into the markets for tomorrow’s meeting of Federal Reserve policymakers.
Investors will instead be focusing on the dot-plot graph of expectations for future rate increases, looking for confirmation that June’s forecast for a fourth rate hike this year, in December, is still on course. Even more important, they will be looking to see if three more rate hikes are penciled in for next year, which would bring the overnight rate to 3.00%-3.25% at the end of 2019.
The other big expectation, based on recent remarks from Fed Chairman Jerome Powell, is to see the word “accommodative” to describe monetary policy dropped from the consensus statement. This omission would free the Fed to continue raising rates to the elusive “neutral rate” that neither stimulates nor dampens growth and even beyond.
Against the backdrop of a robust economy, investors have welcomed the hawkish tilt of the Fed as it sticks to its plan of gradual rate increases while simultaneously allowing its balance sheet to shrink by not reinvesting some of its maturing bonds. That process is known as quantitative tightening, the opposite of quantitative easing.
Major stock indices have surged to record highs, but uncertainties about trade and the length of the recovery cycle are keeping investors on edge and stock markets volatile. So, there will be more attention paid to the GDP forecasts that are released as supplemental material for the FOMC meeting. While the 2018 forecasts have been edging up, forecasts for further out have remained stable. Any shift in those estimates will temper interest-rate expectations.
Hawks Have the Upper Hand
Most of all, investors will be scrutinizing Powell’s press conference for any nuances regarding the economic outlook and monetary policy. Not himself an economist, Powell has abandoned Fed-speak gobbledygook in favor of plain English. But he’s still proven to be adept at not giving too much away. More likely than not, he will simply repeat that the Fed remains convinced of its strategy of gradual increases in interest rates, accompanied by gradual tapering of its bond holdings.
Recent remarks by Fed governor Lael Brainard, considered by many to be the brain of the truncated board of governors, raise the question of whether the neutral rate that should mark the finish line for rate increases is actually a moving target. “With government stimulus in the pipeline providing tailwinds to demand over the next two years, it appears reasonable to expect the shorter-run neutral rate to rise somewhat higher than the longer-run neutral rate,” she said earlier this month in a speech in Detroit.
Along with her willingness to make excuses for low long-term yields and play down any worries about an inversion of the yield curve—where short-term rates are higher than long-term rates—this analysis would seem to open the door for the Fed to go beyond three quarter-point hikes next year, as long as the economy has a full head of steam, without being perceived as restrictive.
The hawkish consensus at the FOMC seems to be growing in spite of traditional hawk-dove divisions on the board. Longtime regional bank doves like Charles Evans of Chicago and Eric Rosengren of Boston rotate into voting positions on the panel next year, but their recent remarks indicate they are supportive of the current tightening policy. Five of the 12 regional bank chiefs vote on an annual rotating basis, with New York getting a permanent vote.
Newly-confirmed Fed vice chair Richard Clarida will take part in the FOMC meeting for the first time and will surely stick with the consensus. The three other nominees that will bring the board of governors to its full complement of seven are awaiting confirmation, but they are all seasoned, pragmatic economists. There’s little reason to think there will be any challenges to the course charted by Powell.