- Financial markets are close to certain that the Fed will lift interest rates by 25 basis points to a range of 1.25% to 1.5%.
- Most interest at this meeting will fall on the Fed’s updated economic and interest rate projections, along with chair Yellen’s post-meeting press conference.
- This will likely be Yellen’s last press conference with Jerome “Jay” Powell set to take on the role of Chair in late February 2018.
The US Federal Reserve FOMC is about to announce its final interest rate decision of 2017.
A 25 basis point hike to the Fed funds rate seen as a lock by markets means that in the absence of a shock decision to not increase interest rates, all attention on this occasion will be on the Fed’s updated economic projections along with Janet Yellen’s last press conference as Fed chair.
As a reminder, here’s what the FOMC’s last economic projections were from its September meeting.
And here’s the Fed’s ‘dot plot’ from that same meeting, showing individual FOMC member forecasts for the Fed funds rate in the years ahead.
The median member forecast for year-end levels in September — which markets tend to react most to, at least initially — was 2.125% for 2018, 2.688% for 2019, 2.875% for 2020 and 2.75% over the longer-run.
After refreshing the memory of what the Fed was thinking in three months ago, let’s see what economists think will happen next.
Here’s just a selection of the notes we’ve received in the lead-up to the December FOMC meeting.
Given the progress toward the committee’s dual mandate, we expect a 25bp increase in the target range for the federal funds rate to 1.25-1.50% at the December meeting. This decision is widely expected by markets.
We expect modest upgrades to GDP growth in 2017 and 2018 and a lower path for the unemployment rate over the forecast horizon. While we forecast that the median number of hikes for 2018 will remain unchanged at three, with more four-hike projections relative to September. Altogether, we look for a 12.5bp increase in the average dot for 2018 and 2019. Further upward adjustment will likely have to wait until either the tax cut passes or there is sufficient evidence to suggest that inflation is firming faster than anticipated.
We no longer expect the committee to pause the rate hike cycle early next year for two main reasons. First, the nomination of Governor Powell as the next Fed chair, in our view, represents a vote for continuity of policy. Second, the unemployment rate is falling again. At 4.1%, the risk of a substantial undershoot is rising.
Even with lingering inflation concerns, we restore a third rate increase for 2018 and now expect rate increases in March, June, and December, which will take the target for the federal funds rate to 2.0-2.25% by the end of the year. Three additional hikes in 2019 would take the funds rate target to 2.75-3.0%. Both are in line with the FOMC median projection as of September.
We see upside risk to our outlook for three interest rate increases next year. The House and Senate have made substantial progress on tax cuts that could begin to influence economic activity in 2018. Fiscal policy stimulus that caused growth in economic activity to accelerate next year would likely lead to a faster pace of normalisation than the FOMC currently deems appropriate.
We expect the FOMC to raise targets for short-term interest rates for the third time this year.
Consistent with sustained economic momentum and strong incoming data during the September-December inter-meeting period, we expect real GDP growth forecasts for 2017, 2018 and possibly 2019 to be revised up.
Since the September meeting, when the most recent unemployment rate reading sat at August’s 4.4%, labour markets have improved further. The unemployment rate for November, at 4.1%, sits a comfortable 0.2ppts below September’s end of year SEP forecast for 2017. Thus, we expect the Committee to lower its median unemployment rate forecast not only for 2017 but also later years as well, including the longer-run. Finally, steady growth in core PCE inflation readings from September and October indicate that the SEP inflation forecasts are likely to remain unchanged at the December meeting.
We expect the distribution of the 2018 dots to shift up but that the median will fall between three and four hikes. This implies that, with 16 participants, the median, conventionally measured, will be 2.250%, the average of 2.375% (four hikes) and 2.125% (three hikes, its current level). It would take upward revisions from four or more participants to push the 2018 median to four hikes. The 2018 median would be three and a half hikes if three participants revise up (our expectation). Finally, if only two participants make upward revisions, the median will remain unchanged at three hikes.
The risk around our forecast appears broadly balanced.
Given the solid economic momentum and the increasing likelihood for tax cuts to come sooner than later, we think it is likely that many FOMC participants will revise up their GDP forecasts for both this year and next. However, the sustainability of this boost to output seems limited.
In our forecast we only see a boost to 2018 growth. We think forecasts for the unemployment rate — currently at 4.3% for Q4 2017 — will move down, although participants may be reluctant to go too low given their latest forecast for the longer-run rate of 4.6%, though they could nudge this lower too. On inflation, we could see the FOMC’s expectations for this year’s Q4 core PCE annual rate edge down to 1.5% from the September 2017 forecast of 1.6%, but it is not clear that the 2018 and 2019 forecasts will change much.
It is far from a done deal that the number of dots will rise in 2018. Given the presentational argument and the voting arithmetic, we believe that the FOMC is more likely to stay at three hikes as the median projection in 2018. However, there is a good chance the median dot could move higher in 2019 and 2010. The overall shift in the dots more broadly will likely be up.
The December meeting and press conference will likely be Chair Yellen’s last. We think it could be her comments on inflation that could carry some weight as the Fed enters 2018.
RBC Capital Markets
The FOMC meeting is the highlight of the week but it is likely to come and go with very little fanfare.
An increase in rates is baked in the cake with the market pricing in 98% odds of a 25bps hike, according to Bloomberg. Likewise, Chair Yellen’s press conference should prove to be a non-event. She just testified before the Joint Economic Committee and thus her most recent views are out there and well-known. She is also leaving once Powell is confirmed so expect the news conference to look more like a deferential sendoff than a grilling. The bigger question is whether the Fed will significantly alter their economic and rates projections. We think not and believe it is more likely the committee will seek flexibility on this front and wait until March to make significant upgrades.
For starters, the Fed will want to wait until they can model the impact of the looming tax plan. Even if it is signed into law by the time the committee meets, there will not be enough time to do a proper vetting of what the plan means for economic growth/inflation/rates. Moreover, by waiting until March to release new estimates, the Fed can still maintain flexibility to raise rates 4 times next year or not. Contingent on tax policy being signed into law, we think members will be out in force on the speaking circuit promoting their upgraded views on the economic backdrop, thus moving the probability of a March hike up sharply through early 1Q (it’s around 60% at present). Then they couple a hike in March with a boost in growth/inflation and their dots profile (moving to 4 hikes in 2018).
The market remains very sceptical of even the current Fed path and does not see a return to “neutral” (which the Fed has pegged around 2.5% nominal) over the next three years. In other words, the risk of a more painful re-pricing is only likely to grow.