What’s The Story Behind These Forecasts?
When deciphering the Fed’s forecasts for economic variables, we think it can often be helpful to look at the story that these forecasts tell collectively. Here’s a look at the current overall picture based on the updated forecasts:
Working from median projections, the Fed expects the economy can grow at 2 percent in the long run. Right now, with the help of fiscal stimulus, it’s growing above that rate. The Fed expects growth will end up at around 3 percent in 2018, then slow down to a still above-trend rate of 2.5 percent in 2019, and then will come back in line with longer-term expectations in 2020. To help control the prospects of inflation that can come with above-trend growth, the Fed believes it will have to gradually raise rates, but doesn’t need to be aggressive. Through the end of 2019, the Fed expects it will raise rates at just about every other meeting to keep inflation under control, and then can slow down from there. If the Fed does that, it believes inflation will stay near the stated target of 2 percent despite the above-trend growth while causing minimum disruption to the economy. Although the Fed is removing added support to the economy, which can be perceived as putting on the brakes, it’s really just trying to get to the point where it’s letting the economy stand on its own two feet.
What The Market Is Saying
That’s a good story, and is largely in line with market expectations, except for the rate hike projections that go with it. The median consensus estimates for growth and inflation from Bloomberg-surveyed economists are nearly identical to the Fed’s outlook. However, fed fund futures’ rate path expectations are considerably lower than the Fed’s. The Fed sees five additional rate hikes by the end of 2020, while the market projects two.
What might account for this difference? Markets may be looking at a pattern of stubbornly low inflation and a Fed that has often had to go slower than expected. The Fed, on the other hand, may want to account for the possibility that growth and inflation could be higher than expected, which would require a more aggressive but still gradual path for rate hikes. Powell did note in his press conference that the impact of fiscal stimulus is still unknown and it’s possible it will be larger than expected. While inflation has remained well contained, possible pressure from wages, trade, oil prices, and potentially stronger economic growth may make the Fed mildly biased toward controlling for inflation risk. The Fed has been generally on target with its rate path forecasts over the last two years, and with maximum sustainable employment clearly in hand, we would be biased toward the Fed’s view over the market’s if the consensus economic outlook comes to pass.
No Longer ‘Accommodative’
The Fed also removed the word “accommodative” from its description of monetary policy in Wednesday’s statement. While we expected the Fed to make this change in an upcoming policy meeting, we didn’t think it would come as soon as last week’s meeting. Because of this, we interpret the removal of “accommodative” as a nod to the Fed’s positive outlook on U.S. economic growth. If the Fed waited too long to change the language, markets may have misconstrued the delay as an implicit message from the Fed that the economic expansion isn’t as healthy as policymakers expected.
Powell noted in his press conference that this change doesn’t signal a shift in the path of monetary policy, but rather reflects that policy is moving in line with the Fed’s expectations. If anything, the removal of the language has a dovish tilt, as it indicates that we are approaching the range of the neutral rate.
The change was unremarkable for markets, the reaction the Fed was likely aiming for. Markets were likely more focused on the dot plot, which—despite the gradual approach—remains markedly more aggressive than fed fund futures’ implied expectations. The Fed will continue to evaluate upside and downside risks based on incoming data, but right now, it doesn’t see any reason to change its policy approach.