BNP Paribas:
We expect the Fed to raise rates on 16 December, for the first time in nearly a decade, and communicate that the pace of hikes thereafter will likely be gradual. The dots should be little changed, along with the economic projections. The risk to our forecast is a decline in the median 2016 “dot”, on account of lower inflation projections. The FOMC statement is likely to describe the risks to the outlook for economic activity and the labor market as balanced.
‘All meetings will likely still described as “live”, and the path of policy as outlook-dependent. In the last couple of months, Fed communication has been crystal clear – on 16 December the FOMC is likely to raise rates for the first time in nearly a decade and embark on a “gradual” normalization of interest rates. The financial markets seem to have the first rate hike close to fully priced in and employment data support the Fed’s case for lift-off.
However, other signs have been less clear, as inflation remains depressed along with wage growth, credit markets are skittish and growth outlooks in emerging markets are challenged. We think the Fed will end up delivering less tightening in 2016 than the 100bp implied by September’s “dot-plot”. Since September’s FOMC meeting, the economic backdrop has been mixed at best. We have seen broad-based signs of slowing momentum, while the cumulative stock of progress has increased (See “
Appendix: US FOMC data dashboard” for full details and Table 1 for the Fed’s last set of projections). Key changes since 16-17 September have been the following: Real GDP growth moderated, but remained above potential (2.1% vs 3.7% q/q saar). Payroll gains bounced back (Chart 1), the unemployment rate fell further, and average hourly earnings growth (% y/y) edged up.
Household spending slowed a bit; while consumer confidence fell. Non-manufacturing sentiment fell, indicating a slower pace of expansion; while sentiment in the manufacturing sector now suggests activity is contracting. Inflation rates remained below target and were little changed on balance. Short-term Treasury yields increased and the yield curve flattened. Front-end breakevens moved higher, equities rose modestly, the dollar appreciated somewhat, energy prices plunged and high-yield spreads widened significantly.
December Summary of Economic Projections (SEP) The December SEP is likely to reveal slightly lower median expectations for the unemployment rate, lower inflation, and minimal, but potentially positive, revisions to growth. These forecasts will likely support, or at least not be, an impediment to the action – a 25bp hike. The Fed seems set on delivering in December.
BNP Paribas Changes to SEP should support December lift off Momentum has slowed a bit, however Fed communication suggests lift-off is near Paul Mortimer-Lee / Laura Rosner 10 December 2015 US Economic Desknote www.GlobalMarkets.bnpparibas.com The Fed is likely to leave its GDP forecast for 2015 broadly unchanged, as the previous forecast was already on the conservative side (2.1% q4/q4 saar).
We could expect further weakness in investment, now that commodities prices have declined further. But they are likely to view the overall consumer picture as somewhat improved: employment gains have been strong (likely exceeding most Fed participants’ expectations), the levels of household wealth and confidence remain high, and the expected rates of headline inflation have fallen.
These influences will likely be seen as positive for growth on net, with perceptions of diminished risks from the external sector likely pushing in the same direction. We expect no change to the 2015 unemployment rate forecast, since it is the average for the quarter, but a slight lowering of forecasts for later years. In September, the low end of the full range of estimates for 2016-2018 was 4.5%, and it is surprising to us that no one thought the unemployment rate might continue to decline at its recent pace (on average down 0.75-1.0pp per year over the last several years).
Recent declines in commodities prices could prompt downward adjustments to the FOMC’s headline inflation projections for 2016, but probably not 2015, since crude oil prices affect pump prices with a lag. The median-2016 forecast could fall by at least a tenth. Unrelated to oil, we expect the 2015 core inflation forecast to be nudged down a tenth due to recent disappointments in the pace of monthly gains. The forecast for 2016 could also come down slightly if participants anticipate additional leakage from lower energy prices.
We expect few changes to the median path of rates implied by the Fed’s “dot-plot”, but a move lower is also possible, especially if participants lower their inflation projections, as we expect. However, even if the median “dot” were to shift down by 25bp, the median path of rates would still likely imply more hiking in 2016 (75bp) than the market currently expects (around 50bp). We expect some divergence to persist beyond lift-off and some convergence to occur when lift-off is actually announced. Policy statement Key changes to the policy statement will come in the outlook and forward guidance paragraphs. First, the FOMC is likely to say that the risks to the outlook for economic activity and the labor market are balanced.
Yellen and others have foreshadowed this change in recent speeches by calling the risks “very close to balanced.” In the forward guidance paragraph, we expect two key changes: 1) the first hike will likely be announced and 2) the last sentence, which provided guidance about the timing of lift-off, is likely to be dropped. In terms of guidance about future hikes, we expect the Fed to repeat that: “in determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress—both realized and expected—towards its objectives of maximum employment and 2 percent inflation.”
It is also likely to repeat that “even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer-run.” Keeping in the phrase “at its next meeting”, as we expect, could be interpreted hawkishly by the markets, even though it would not be news. When the Fed introduced that phrase into the statement in October, the markets were not thinking about January, they were focused on December. Once lift-off is behind us, the attention will shift to the next meeting (January) and right now the markets may not be fully appreciating the concept of “live meetings”.
Moreover, the Fed would not want to add back the language, potentially every other meeting, to signal meetings when they plan to hike rates. In the paragraph describing current conditions, the description of labor markets will likely be upgraded given the recent string of strong payrolls reports. Previously the assessment was that “the pace of job gains slowed”, but on 16 December it will likely be changed to “the pace of job gains picked up”. The Fed’s assessments of household spending and business fixed investment are likely to be downgraded, as both have slowed recently. Rather than “increasing at solid rates in recent months” the Fed could say they are “rising at moderate rates”.
Net exports will likely still be described as “soft”. Crude oil prices have dropped more than 15% since policymakers met on 27-28 October, but the 5y5y forward breakeven rate has risen more than 5bp. The two measures have been Oil prices down, inflation expectations up? Risks are balanced The first rate hike in nearly a decade… Employment gains have been remarkable Oil price drop to influence inflation forecasts Unemployment forecasts could be lowered Overall, Fed forecasts are likely to change little If the dots move, they should move down Paul Mortimer-Lee / Laura Rosner 10 December 2015 US Economic Desknote www.GlobalMarkets.bnpparibas.com positively correlated this year, even though their relationship historically has been negative.
The FOMC will likely play it safe and say that market-based measures of inflation compensation “remained at low levels”. Its assessment of survey-based measures of inflation expectations is also unlikely to change since the Chair recently downplayed the decline in the University of Michigan measures and characterized other survey measures as generally stable. Press conference Our key expectations for the press conference are for the Chair to: (1) explain why the FOMC has decided to raise interest rates for the first time in nearly a decade; (2) emphasize that it is the markets’ expectation for the whole path of rates which matters most to financial conditions, not the timing of the first move;
(3) reiterate the Committee’s current expectation for the pace of hikes to be gradual; (4) explain why the stance of policy is still very accommodative; (5) provide guidance about what will determine future adjustments in the target rate range, highlighting that the Committee’s decisions will be outlook-dependent1 ; (6) highlight that the FOMC could speed up or slow down the pace of rate hikes, depending on how incoming data affect their outlook; (7) discuss how the FOMC plans to execute the rate hike, referencing an implementation note that we expect will be released at the same time as the policy statement.2 On balance, we don’t expect any surprises.
If the phrase “at its next meeting” is kept in the policy statement, as we expect, Yellen is likely to dampen expectations of a January hike during the press conference by referencing the “median” path of rates in the SEP, and reiterate intentions to normalize at a gradual pace. Due to year-end and liquidity concerns, it could take a bit of time to see the market’s full response to lift-off and the guidance which accompanies it. Risk appetite seems to be low. After the New Year, investors may be more willing and able to take on positions to express views about the pace of hikes.
In a 2 December speech, Chair Yellen said that “the actual path of monetary policy will depend on how incoming data affect the evolution of the economic outlook.” 2 The June FOMC meeting minutes revealed that all participants supported issuing a separate implementation note at the same time as the policy statement which would “communicate separately from the Committee’s postmeeting policy statement the specific measures to be employed to implement the FOMC’s decision about the stance of policy.”
