Green Smoke Rising From Fed As FOMC Conclave Ends
The shorter FOMC preview: the green smoke rising from the Marriner Eccles building is not because a new Fed pope was picked. For the longer FOMC preview: here is Goldman Sachs...
Goldman Sachs does not expect any policy changes - or change in message - at the March 19-20 FOMC meeting. The committee is likely to recognize the recent improvement in the data through a modest upgrade of the outlook paragraph in its statement and its updated forecasts. But Goldman does not expect the statement or the post-statement press conference (which has been brought forward in the Fed';s new exciting communications policy to avoid market volatility) to signal increased concerns about costs and risks of QE, nor do they expect much additional clarity on what constitutes a "substantial improvement" in the labor market (as we noted yesterday). So bottom-line, more of the same...
Via Goldman Sachs,
Q: Will the FOMC announce major policy changes?
A: No, we do not expect any policy change at the March 19-20 FOMC meeting. Although the economic outlook has improved a bit since the January 30 meeting, we expect the Fed's asset purchases to continue until 2014Q3 and do not project the first rate hike until early 2016. We therefore think it is too early to signal any changes to Fed policy.
Q: Will Fed officials recognize the better data?
A: Yes, the committee will likely acknowledge the upturn in the dataflow. The modest upgrade is likely to be primarily reflected in the outlook paragraph of the FOMC statement (released at 2pm). For example, the committee could decide to replace “growth in economic activity paused in recent months” with “growth in economic activity and employment has resumed at a moderate pace.” We also anticipate a small upgrade of the committee's forecasts in the Summary of Economic Projections (SEP, also released at 2pm). Specifically, we expect that the FOMC will forecast a bit more real GDP growth in 2013 and 2014 (2.7% and 3.4% on a Q4/Q4 basis, respectively) and unemployment of 7.4%, 6.8% and 6.1% at the end of 2013, 2014 and 2015, respectively.
Q: Will the FOMC signal increased concerns about costs and risks of QE?
A: We do not expect the FOMC statement to include additional references to the costs and risks of QE. Fed communication since the January FOMC statement has increasingly focused on the costs of continued asset purchases, most notably in the January meeting minutes which revealed that "a number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred." But the FOMC leadership has since clarified that it does not share this view. Chairman Bernanke reiterated in his Congressional testimony on February 26 that the committee will "continue purchases until it observes a substantial improvement in the outlook for the labor market." Vice Chair Yellen stated on March 4 that "at this stage, I do not see any [costs] that would cause me to advocate a curtailment of our purchase program." Costs and risks of QE are, however, likely to come up in Chairman Bernanke's post-statement press conference. We would expect him to strike a similar tone to his Congressional testimony, stressing that costs are important but that the benefits of QE continue to outweigh the costs and that it is primarily the state of the labor market that will determine the end of QE.
Q: Will Fed officials provide additional guidance on what "substantial improvement in the labor market outlook" means?
A: We do not expect the FOMC to provide more specific guidance in the FOMC statement and think that the adoption of a QE threshold is unlikely. We do, however, expect Bernanke to be asked to specify what "substantial improvement" means. Following Vice Chair Yellen's recent speech, we would expect him to stress that it is an improvement in the labor market outlook that is required which, in turn, necessitates a broad improvement in labor market indicators. In addition to declines in the unemployment rate, Vice Chair Yellen argued that she would need to see strong payroll growth, improvements in hiring and quit rates and a pickup in real GDP growth.
Q: Are participants' projections for the appropriate funds rate likely to change significantly?
A: Although some switches towards earlier hikes are conceivable, we do not expect a significant change from December's SEP (in which two participants project the first rate hike for 2013, three for 2014, 13 for 2015 and one for 2016). Given the slightly better data we think it is conceivable that one or two participants move their first rate hike from 2015 to 2014 and/or that the participant with the first rate hike in 2016 pulls this into 2015.
Q: What is left in the arsenal?
A: Chairman Bernanke might be asked what tools the FOMC could employ should the economic outlook deteriorate sharply, for example, through a re-intensification of the Euro area crisis. We would expect him to stress that the current threshold guidance already provides an automatic mechanism for additional monetary easing as the expected date for the first rate hike would automatically be pushed out if the unemployment rate was expected to decline more slowly to 6.5%. We would expect him to say that, if additional monetary accommodation was required, the first line of defense would be additional forward guidance--either through a reduction in the unemployment threshold for the first hike below 6.5% or through a longer period for QE--rather than an increase in the monthly pace of asset purchases.
Q: What are the potential surprises?
A: An increased emphasis on the costs and risks of QE would be a hawkish surprise. This would be especially true in the FOMC statement (and we think this is therefore quite unlikely). But even if Bernanke stressed the cost side of QE more than in his recent monetary policy testimony, this would be noteworthy. Secondly, a Bernanke endorsement of Chicago Fed President Evans' threshold for ending QE--if monthly payroll growth exceeded 200,000 for six months--would be a hawkish signal. As payroll growth has averaged 187,000 over the last six months, we are getting closer to this threshold and any endorsement of this rule might suggest that QE would end sooner than expected. Finally, dropping the "downside risk" phrase in the statement--motivated, for example, by the declining risks around the fiscal outlook--would clearly be a hawkish surprise. We think this is unlikely, however. We believe the fact that the committee just dropped the "significant" in that phrase at the last meeting reduces the chance of another change to this key phrase so soon after, especially because concerns around the Euro area have, if anything, risen since January 30 in light of the news out of Italy and Cyprus.
A dovish surprise would be if the committee and/or the Chairman expressed explicit skepticism about the sustainability of the recent upside surprises on growth and employment. He might articulate this either in the statement (for example, by including a reference to the fiscal drag ahead) or in the press conference (for example, by stressing the temporary positives such as the inventory boost and that the jury is still out on the effects of the tax increase on consumption). Another potential surprise would be an endorsement of Boston Fed President Rosengren's view that the committee should continue to purchase assets at least until the unemployment rate declines to 7.25%. Finally, we would look for dovish surprises in the inflation outlook, including the extent to which the committee marks down its core PCE inflation forecast and the emphasis Bernanke places on the recent deceleration in core PCE inflation in the press conference.
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