The Federal Open Market Committee (FOMC) begins its meeting today. The FOMC meeting announcement and forecasts are out at 2 p.m. ET on Wednesday, followed by remarks from Federal Reserve chair, Janet Yellen, at 2:30 p.m. ET.
The FOMC is largely expected to taper its asset purchase program by $US10 billion to $US35 billion.
Effective July 1, the Fed is expected to lower its asset purchases to $US15 billion in agency mortgage backed securities (MBS) and $US20 billion in Treasuries.
The Fed is also expected to maintain its current forward guidance language on federal funds rate support.
The latest consumer price report showed that inflation is starting to tick higher. Following the report, Ian Shepherdson at Pantheon Macroeconomics wrote that he doesn’t expect a “knee-jerk Fed reaction,” but “If these emerging trends continue, markets and policymakers will soon be changing their tunes.”
“It undoubtedly will colour the discussion on the FOMC, and may embolden some of the hawks to push up their inflation and interest rate forecasts,” writes Michael Hanson at Bank of America. “While we don’t expect a hawkish dissent at this meeting, today’s numbers mildly increases those odds.”
Unemployment and growth
Yellen is clearly looking beyond the headline unemployment rate. Her “eclectic” approach, writes David Rosenberg at Gluskin Sheff, includes quit rates as a sign of investor confidence, and part-time and long-term employment data.
“The bottom line, though, is that employment lags the cycle, unemployment rates lag employment, and wages lag everything,” writes Rosenberg. “So what we have is a Fed that is committed to targeting lagging indicators — this can only end up building more inflationary pressures down the pike.”
The FOMC “will maintain its focus on the potential for a cyclical growth pick up and a further reduction in labour market slack,” writes Mohamed El-Erian. “It will also note the importance of removing the slack given its more holistic assessment of the labour market (which includes part time activities, long-term joblessness, and wage growth).”
Another number FOMC members will be tossing around is the slowdown in the first quarter, though this is likely to be considered a one-off. El-Erian writes that this is likely to show “some softening in the shorter term growth projections but no material change to longer-term expectations.”
In fact, in some regards the Fed looks close to achieving its employment and inflation goals. Recently, Goldman Sachs’ Jan Hatzius wrote that “despite the 1% drop in real GDP in the first quarter, we believe that the US economy is now growing at an above-trend pace.” This could have bulls antsy about the Fed’s accommodative stance.
New Fed faces and the Dot Plot
There is a little uncertainty about the policy debate going in to this meeting since Lael Brainard and Stanley Fischer, who were confirmed last Thursday, will be stepping up as new voters. Meanwhile, Loretta Mester, who took over from Cleveland Fed President Sandra Pianalto, is also stepping up as a voter. Hatzius argues that these new faces could result in a “dovish shift.”
“This change-over will add some uncertainty to the policy debate and the distribution of the June ‘dot plot,'” writes Michael Hanson at Bank of America. “We don’t expect these current or potential future personnel changes to fundamentally alter the majority support for a gradual exit with rates below their historical average for some time.”
Michael Hanson and Ethan Harris expect that Yellen will downplay the “dot plot” as not being a policy tool. This refers to the the dot chart that shows the predicted path of the federal funds rate, where each dot represents where an FOMC member sees the federal funds rate at the end of each year. They expect the first rate hike in Q4 2015.
“The committee is likely to make some upgrades to its description of the economic outlook in the post-meeting statement and its economic projections,” writes Hatzius. “Although the committee will need to reduce its 2014 real GDP growth forecast to take into account the Q1 disappointment, we would expect the committee to reduce its unemployment rate forecast and lift its inflation forecast slightly.”
Here’s a quick look at what Goldman expects:
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