Commentators and markets are making lots of noise after the FOMC statement and Chair Yellen’s press conference. Everyone is focused on the idea that a policy move in June is now all but off the table, but that is not where the real story lies. To be sure, the FOMC has scaled back its GDP growth projections for each year 2015-2017 from its December projection and has also reduced its PCE inflation forecasts for 2015 and 2016.
At the same time, its forecasts remain optimistic for ongoing reductions in the unemployment rate throughout the forecast period and even into the “longer run.” While some may question the internal consistency of these joint forecasts, the interesting story in the context of these projections lies in the dot chart depicting FOMC participant’s assumed path for the end-of-year federal funds rate that generated the forecasts.
Comparing the December 2014 dot chart funds rate assumptions versus those for this March reveals a notable scaling back. In December only 6 participants had the funds rate for 2015 at 1 percent or less, whereas in March 13 participants had the funds rate below 1 percent, and of those 13, 10 had the funds rate in the 50 to 75 basis points range. Moreover, the dispersion of the 2015 funds rate projections was also significantly reduced in March.
Last December, 11 participants had the funds rate in excess of 100 basis points by yearend 2015, and 5 had the rate in excess of 175 basis points. By March only 4 participants having the rate between 100 and 175 basis points, and only one was above 2 percent. A similar compression in the distribution of the assumed federal funds rate is observed for 2016. In December 14 participants had the 2016 funds rate in excess of 2 percent, and 7 had the rate at 3 percent or greater, with 4 being between 3.75 percent and 4 percent. In the March forecasts, only 6 participants had the funds rate above 2% while 11 participants were below that.
The distribution is even tighter for 2017 and has also shifted somewhat lower. The conclusion is that not only have the funds rate assumptions been reduced, but also those reductions were not sufficient to offset declines in the forecasts for real GDP and inflation.
Despite the emphasis given to the removal of the word patience from the March FOMC statement, the dot chart suggests three things. First, the path for the funds rate is now substantially lower than it was in December, reflecting the more somber tenor of the forecasts for GDP and inflation. Second, not until 2017 does more than one FOMC participant see the funds rate target as a point estimate as opposed to a range of 25 basis points.
This suggests the Committee is still thinking of moving the funds rate band as it normalizes policy rather than switching to a single funds rate target similar to the policy followed prior to the financial crisis. Third, the most likely range for the funds rate by December of 2015 is 50-75 basis points based upon the dot chart.
This implies there will be at most two moves between now and the end of December. Even if the FOMC skips a meeting between rate moves, which is highly unlikely, the earliest that the first move would likely occur would be September of this year. But if the more likely sequential path is followed, then October is now the date for the first rate move.
Of course, it is perfectly clear that the Committee’s decisions will be data dependent, but we have learned very little from Chair Yellen’s press conference about what data or how dependent a policy move will be. The bottom line is that the Committee could have replaced the word patient with extremely cautious and been totally consistent with the SEP forecasts. Such caution is going to continue to be positive for equity markets, in particular, and at Cumberland we are fully invested.