FOMC Minutes Preview: "The Most Likely Surprise Is 4 Rate Hikes In 2018"

The Dollar is suddenly rising and rate hike expectations are now at their highest of the cycle - 2.76 hikes in 2018 are priced in - (despite stocks still not being anywhere near back to pre-Powell-put-implied levels).

But as Rafiki Capital Management's Steven Englander notes, the most likely surprise in the Fed Minutes tomorrow is that they may be leaning to four hikes in 2018, but the biggest surprise would be growing support to aim for above two percent inflation temporarily to make up for previous misses to the downside.

The three versus four hike debate is already in the open with several FOMC participants referring to the possibility of four hikes.

About 70bps are now priced in, versus around 65bps just before the meeting. The FOMC meeting occurred before high AHE and inflation prints, but in recent meetings the Minutes' discussion has become more confident that inflation is picking up.  I think the risk is much greater that they signal growing confidence on inflation moving towards target more quickly than any indication that two hikes might be more appropriate than three.  

This would not mean a strong, overt signal of four hikes but it is likely they could convey 'three, maybe four' as their stance. 

They are unlikely to go full hawkish in the Minutes as there have been only moderate hawkish signals since, and monetary policy was probably discussed in between tinkling champagne glasses at Fed Chair Yellen's last meeting.

The problem for the inflation doves is that even if they are ultimately proved right, there haven't been any recent data releases that would support the view that inflation will persist below two percent. The characterization of the dovish stance in the December Minutes now reads too aggressive:

'With core inflation readings having moved down this year and remaining well below 2 percent, some participants observed that there was a possibility that inflation might stay below the objective for longer than they currently expected. Several of them expressed concern that persistently weak inflation may have led to a decline in longer-term inflation expectations; they pointed to low market-based measures of inflation compensation, declines in some survey measures of inflation expectations, or evidence from statistical models suggesting that the underlying trend in inflation had fallen in recent years."

Many of the factors the doves cite had turned before the FOMC (and have continued to move in that direction) so the discussion of downside inflation risk will become more tentative, and of upside risk, more concrete. 

The bigger issue is whether they want to temporarily aim for inflation above two percent.  That discussion is simmering but with the January 31 meeting having been Fed Chair Yellen's last, I doubt that they wanted to stir that pot just yet, given that they are in no position to make a decision.

Recent Fed Statements have referred to the 'symmetric inflation goal' and The Statement on Longer term Goals and Monetary Policy Strategy, released at the January meeting, also refers to  'symmetric' targeting of two percent inflation. 

To most of us a symmetric inflation target means that we are as grieved by missing 0.2 percentage point to to the downside as to the upside. If you wanted to make up for past misses, it would be more correct to refer to a price level target. However, the June 2017 Minutes said:

"It was also suggested that the symmetry of the Committee's inflation goal might be underscored if inflation modestly exceeded 2 percent for a time, as such an outcome would follow a long period in which inflation had undershot the 2 percent longer-term objective."

which looks as if 'symmetric' could be seen as meaning making up for downside inflation misses with upside misses, at least in part. And some FOMC participants have used symmetric in a similar context.

So far the Minutes have been coy about this possibility. The Minutes to the Dec. 2017 meeting stated:

"...a few participants suggested that further study of potential alternative frameworks for the conduct of monetary policy such as price-level targeting or nominal GDP targeting could be useful."

I doubt there would be much change in this language until they have a good idea where they are headed and that is not the case now.  The mention in recent speeches has been casual, more discussed as a possible tweak, than pushed as a full-fledged policy alternative, so even it there are good arguments for it, I doubt that tomorrow's Minutes is where it would be introduced as a full-fledged alternative. If I am wrong and the Minutes sound as if this target shift is under serious consideration, the USD would come under significant renewed pressure. 

We would probably see some curve steepening as the shift is digested. 

Bottom line: I go in with a hawkish lean, thinking that 75-80bps of 2018 hikes is closer to accurately pricing in the fed tilt and the current economic/inflation outlook.