Some folks will be talking about the Fed today.
In just a few hours we’ll get a hike, but once again, it’s all about the messaging. Any kind of dovish lean would be a (bigly) surprise. What’s got some people spooked is the possibility that, in their rush to prove they aren’t behind the proverbial curve, they get too aggressive with the messaging. Here’s what SocGen said overnight (and please, just forget that you ever heard the term “pussy-cat” in a sentence that refers to Janet Yellen):
The Fed is a pussy-cat that would like to change its spots into something more like a leopard’s. In practical terms, that means that this evening’s FOMC announcement (6pm GMT, with a press conference half an hour later) is all about the Fed’s projections rather than whether they raise rates or not. Anything other than a 25bp rate hike would be a huge surprise to the market. Discounting that possibility on the grounds that the Fed is so (too) obsessed with managing market expectations ahead of policy moves, what we’ll watch are the ‘dots’ showing FOMC’s projections of where Fed Funds might go. Market pricing of Fed Funds through 2017- 19 is at the bottom of what the Fed currently projects. Our US economists think that the 2017/18 dots probably won’t move but beyond that, an upward adjustment is possible to send a signal to the market that the FOMC is serious about normalising policy.
Yes, “to send a signal to the market that the FOMC is serious about normalizing policy.” And see that’s the problem. The Fed already tried that. And since March odds converged on 100%, we’ve seen nothing but signs that while this market will probably be willing to write off one hike as a positive development (you know, as confirmation of the reflation narrative’s legitimacy), anything beyond that in terms of an overzealous normalization trajectory could very well trigger a tantrum and undercut oil prices further.
So is the Fed behind the curve? Or, put differently, are we right to fear an FOMC that sees itself as playing catch up? In short, probably. Here’s Goldman:
Exhibit 1 shows the gap between the funds rate and the rule-implied rates. Positive values indicate that policy is “too tight,” while negative values indicate that policy is “too easy.” The results using the HLW estimate of r* imply that policy is just over 1pp easier than the rule-prescribed rate, while the results using a 2% neutral rate imply that policy is almost 3pp easier. Accounting for the impact of the balance sheet would make both gaps moderately larger. The constant neutral rate assumption implies that the current policy stance represents the largest dovish policy deviation since the 1970s, though it is only half as large as the most extreme gaps of the 1960s and 1970s.
If the Fed is behind, what would it take to catch up? Last week, we showed that the Fed’s projections over the next few years already correct the modestly “too easy” stance implied by its depressed r* view. Under the alternative assumption that critics of the low r* thesis are right and a 2% neutral rate is a better guide, current policy is about 3.5pp too easy and the Fed’s terminal rate estimate about 1pp too low, requiring 1 additional hike per year beyond those already planned to catch up by 2020.
Got that? Ok, good.