Fourth hike for 2018 is still hanging in the balance - Rabobank

Analysts at Rabobank noted that, as well telegraphed, the FOMC raised the target range for the federal funds rate to 1.75-2.00% from 1.50-1.75%

Key Quotes:

One higher dot, one extra hike?

"There were no dissenting votes. More interestingly, the dot plot looked more hawkish as the median projection now implies 4 hikes in 2018 instead of 3 hikes as in the March SEP. However, this reflected on balance only a single dot moving up. In fact, during the Q&A at the press conference Chairman Powell said that most participants did not change their rate projections. Back in March, 7 dots implied 4 or more hikes versus 8 dots that implied 3 or fewer hikes. This time it is 8 versus 7. What’s more, the dots reflect all participants in the FOMC, including the non-voters. In fact, it could be the case that the shifted dot represents a non-voter. All’n all, the shift in the dot plot may not be as significant as would appear at first sight. It seems that the fourth hike for 2018 is still hanging in the balance with only a minimal majority for the 4+ crowd among all participants."

Asymmetric symmetry

"Meanwhile, the dot plot still implies 3 hikes for 2019. This means that the FOMC expects to overshoot its (unchanged) longer run neutral rate of 2.9% before the end of 2019. This seems consistent with the projected overshoot of PCE inflation to 2.1% in 2018-2020; back in March the FOMC did not expect an overshoot until 2020. In line with an upward revision of the inflation projections, the Committee made downward revisions to the unemployment rate projections to 3.6% in 2018 (from 3.8%) and 3.5% in 2019-2020 (from 3.6%). In contrast, the projections for GDP growth remained unchanged for 2019-2020, but were revised upward to 2.8% in 2018 (from 2.7%). However, the size of the projected inflation overshoot remains at odds with the FOMC’s verbal emphasis on the symmetry of its 2% target after several sustained episodes of inflation undershoot in recent years."

Dropping words, adding press conferences

"The change to the FOMC statement was significant however, with the removal of the phrase that the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. This is an acknowledgement by the Committee that with the neutral longer run fed funds rate estimated at 2.9% by the FOMC participants the policy rate is rapidly approaching restrictive territory. The next change in this regard is most likely the removal of the language about the accommodative nature of the stance of monetary policy. During the Q&A, Powell said that we will relatively soon be in the zone of a roughly neutral policy rate, which implies that monetary policy is not accommodative anymore at that time."

"Moreover, the FOMC statement was more confident on inflation, dropping the phrase that the Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. On the real economy, the Fed noted that the unemployment rate declined, that economic activity has been rising at a solid (instead of ‘moderate’) rate and that growth of household spending has picked up (instead of ‘moderated’)."

"At the press conference Powell announced that starting in January 2019 he will give a press conference at each meeting. However, the projections will continue their quarterly schedule. This will reduce the difference in importance between the meetings with and without projections, although it will not eliminate it entirely. However, it will make it easier for the FOMC to explain any change in policy at the meetings without projections."

"According to schedule, the caps of the balance sheet normalization program will be raised next month to $40bn (= $24bn treasuries + $16bn agency MBS/debt) from $30bn (=$18bn + $12bn). Only principal payments that exceed these gradually rising caps will be reinvested. The next adjustment is scheduled for the September meeting when the total cap should rise to $50bn from $40bn."

A smaller hike for the IOER

"While the target range for the federal funds rate was raised by 25 bps, the IOER was raised by only 20 bps. This is a more technical adjustment to monetary policy. Due to the Fed’s reduced balance sheet, the fed funds rate has been moving well into the upper half of the target range, instead of remaining near the midpoint. So monetary policy has been a little more restrictive than suggested by the target range. Note that the upper and lower boundaries of the target range are merely announcements made by the Fed; they do not reflect market instruments that influence the fed funds rate. The current hiking cycle is implemented by increases in the interest on excess reserves (IOER). In theory, this rate should be a floor for the fed funds rate as any market participant in the federal funds market would require at least the IOER. However, since not all participants have access to the IOER – most notably the GSEs are excluded– the fed funds rate has in practice been somewhat below the IOER. Nevertheless, through arbitrage the spread between the IOER and the fed funds rate is bounded. Consequently, it has been possible to raise the fed funds rate through increases in the IOER, although with the IOER set at the top of the target range instead of the bottom. At this location, the IOER has kept the fed funds rate around the midpoint of the target range for several years. However, the spread between the IOER and the fed funds rate has decreased over time, so in order to push the fed funds rate back to the midpoint of the target range the Fed has decided to set the IOER 5 bps below the top of the target range."

Conclusion

"At closer inspection the shift in the dot plot does not seem significant, and the fourth hike for 2018 is still hanging in the balance. While the change in the forward guidance of the FOMC statement is significant it reflects the fact that we have moved closer to neutral. Meanwhile, we have our doubts about the Fed’s optimism on inflation as long as the Phillips curve refuses to materialize. Therefore, for now, we stick to our call for three hikes this year (March, June, September)."