FOMC Preview
When the Fed meets next week, the market generally expects that policy makers will raise rates for the 3rd time in 6 months, moving the median Funds rate to 1.125%. Despite rising anxiety on inflation after a below trend 1Q:17 GDP print, the Fed’s desire to continue the normalization policy is viewed as outweighing these concerns at the moment. The minutes to the May meeting affirmed this view with most on the committee finding it appropriate to continue removing monetary accommodation, a message that has been mostly affirmed by recent Fed speakers. While weak data was generally viewed as transitory the last time the Committee met, recent Fed speak has moved to a more cautious tone, with several members recently raising inflation concerns. Ultimately, we do not think that these concerns will play into their June decision, especially with June odds above 90%, which may be the most important data point at this moment. Therefore, presuming they raise rates next week, investors will then turn their attention to the Fed’s view on rate hikes for the remainder of 2017 and its plans for 2018. Encapsulated in this discussion will be an update to the economic projections, which was last revised during their March meeting. As the table below indicates, GDP, unemployment and inflation are all running below the Fed’s full year projections, likely requiring that they bring this data closer to actual results. The weak 1Q:17 GDP results have been characterized as transitory by the Fed, a view supported by the 3.4% and 2.2% current quarter estimate provided by NOWCAST and GDPNOW tracking tools. Therefore, we don’t think that the Fed needs to update its GDP forecast during next week’s meeting, thereby sending the message that things are progressing as expected. In contrast, unemployment is already below its year end forecast which will likely require and adjustment to at least matching the last 4.3% reading. With weekly claims remaining near lows last seen in the 1970s and recent JOLTs data at record highs, there are no indications that the UER cannot be pushed down further. The trickiest change will be in its inflation expectations, particularly given that the FOMC will be forced to move its full employment goalpost, with the old target yet to generate wage inflation. As both the headline and core PCE readings have weakened recently, the changes adopted by the Fed will present an outlook on the permanence of the recent downturn in pricing pressure. The ECB provided a glimpse on the longer term inflation challenges as it lowered its targets through 2019, despite upgrading its growth outlook.