Fra BNP Paribas:
US FOMC: Keeping options open
With the much-anticipated winding down of the Fed’s balance sheet expected to begin at the September FOMC meeting, the focus is on the outlook for rates.
The Fed is unlikely to pay much heed to the one-month bounce-back in inflation.
We think the overall tone of FOMC communication will be cautious as it waits to assess the impact of the balance sheet unwind as well as for more confidence in the inflation outlook. We expect the key action point of the FOMC meeting on 19–20 September to be the formal announcement that it will start its balance sheet run-down in October.
We would be surprised if the committee deviated from the Policy Normalization Principles and Plans it published in June. The economy is on a solid footing, both in terms of activity and the labor market. The FOMC’s overall assessment of the economic growth rate should not change that much, although there should be reference (at least in the press conference) to the likely data distortions caused by Hurricanes Harvey and Irma.
A few FOMC members have already noted that their ultimate
impact is difficult to assess but likely to be close to net neutral over the long run.
The market focus will likely be on what the Fed says about the inflation outlook after one good print, following a string of downward surprises. We think the statement is likely to say that inflation continues to run below 2%, with little credence given to the one-month bounce.
Chair Janet Yellen is likely to say that inflation developments are being monitored closely but that the decline over recent months has been idiosyncratic. The extent to which she stresses idiosyncratic rather than structural explanations for the decline should be important to the markets. At this stage, we would expect the Fed to adopt a ‘wait and see’ attitude and look for more evidence.
In terms of the ‘dots’, we expect the number of rate hikes that the FOMC members see as
appropriate to drift down for both this year and next, but probably not enough for the median dots to suggest no further rate hike this year; nor do we expect to see the number of dots for next year to slip from three to two. The median estimate of the equilibrium level of unemployment might edge down again.
Overall, we expect the FOMC will want to stay away from sounding hawkish, given the
tightening implied by the expected balance sheet action and low inflation. But at the same time, it might want to avoid creating such a dovish impression that the market would effectively price out a December hike.
At this stage, we expect the policymakers will want to keep their options
open. If they do not manage to strike that balance, our expectation would be for a more dovish slant that would support our call for no rate hike in December.
