Here's What The Fed Will Say Tomorrow

There is one thing that is certain ahead of tomorrow's FOMC meeting, at least according to the market: the Fed will hike rates.

Besides the Fed Funds futures markets, one big tell that markets have taken a hawkish turn as Steven Englander points out is that 2yr yields went up yesterday despite the absence of economic data and a seriously downbeat equity market. Today, equities were generally flat, with no data released, and short term yields keep rising. Additionally, the sharp bounceback in 10yr yields on flat S&P futures indicates that fears of a hawkish FOMC outcome are growing.

The question then is whether the Fed will hike rates 3 or 4 times in 2018 and 2 or 3 times in 2019. Here opinions differ, and as Morgan Stanley writes, based on our stress-testing of the dot plot, it is possible to get to a full median of 4 hikes in 2018, particularly if the Chair moves, "but we think it is too early in the year for the FOMC to agree more tightening is needed, particularly in light of continued uncertainty about just how much tightening the first full year of balance sheet shrinkage will deliver. Also, having over-promised and under-delivered on rate hikes in 2015 and 2016, we think the FOMC will be reluctant to raise the median path too aggressively early this year and risk a repeat scenario—at least at this meeting."

Here the gating factor will be the yield curve, which at the current rate, will likely be flat or inverted by September:

By September, a flat-to-inverted yield curve, continued balance sheet runoff and tighter financial conditions, as well as higher positive real rates will warrant close examination of how much further the FOMC wants to push rates in this cycle. Thereafter, we expect that in early 2019, fiscal stimulus will push a very late-cycle economy to new heights, leading the Fed to hike two additional times—in March and June. With the midpoint of the target range near neutral (at 2.625%), this is likely where the hiking cycle ends in this expansion.

For now, however, there is just one question on every trader's mind: will the Fed telegraph 3 or 4 hikes tomorrow. And while most banks expect an upward drift in the dots to raise the median across most of the forecast horizon, they note that it will be a high hurdle to get all the way to 4 hikes in 2018 (not for Goldman though, whose base case is 4 hikes and potentially even 5).Others,such as Morgan Stanley expect the median to remain at 2.125% in 2018, because as many as 3 participants could add a 4th hike at this early stage—before confirmation of the "kink" in core inflation coming out, and before even the first official take on 1Q GDP —and the median would still be unchanged from December.

In other words, for the median path in 2018 to move to 4 hikes the dot plot would need at a minimum all but one participant currently at 3 hikes to move to 4. The following table illustrates just what it might take.

Goldman agrees, and writes that while its own forecast is that the FOMC will deliver four hikes both this year and next year, it expects a more measured increase in the dots next Wednesday, as shown in Exhibit 6.

By our count—which factors in Yellen’s departure and our expectations for the other participants—four members would have to boost their projections above the December median (of three hikes) for the March SEP to show a four-hike baseline in 2018. Six individuals projected a three-hike 2018 pace at the December meeting (i.e. just one hike below four), and given the upbeat public remarks and encouraging data, we believe such an increase is indeed likely. We also expect the 2020 median dot to increase, but by less than half of a hike.

We will have more to say about the dot plots in our full preview later today, but before previewing what the FOMC statement could look like, here is another interesting assumption from Morgan Stanley: Fed chair Powell could change the FOMC format to add a press conference after every meeting, thus making every meeting potentially live.

Press conference following every meeting?

Under Chair Powell's leadership, we expect the FOMC to adopt the practice of holding a press conference following each of its 8 meetings per year, likely to come as an announcement at the December 2018 meeting (to begin in 2019). While previous Chairs Yellen and Bernanke focused on being highly prepared for every press conference (making each one quite an endeavor for Chair and staff alike), Chair Powell has already shown in testimony he may be more willing to speak off the cuff, taking a more casual approach.

Processes are formal within the Federal Open Market Committee, and evolve slowly. We think it would likely take about nine months from the time the idea is submitted for Committee discussion to the time of execution. Follow the minutes
of meetings this year to gauge when the idea is proposed, how it evolves, and eventually we might be able to anticipate its announcement.

Chair Powell has committed to continuing transparency in Fed communications under his leadership. Moving to a Q&A after every meeting is consistent with that view, but will need to be meticulously laid out so that markets are well  prepared —and so that the move alone isn't taken as a sign the FOMC is ready to speed up the pace of hikes.

Again, there will be more in our full FOMC preview due shortly, but for now, we leave readers with two preview blackline statements, one from Morgan Stanley and one from Goldman Sachs, laying out what and where the two banks expect to see notable changes to the Fed language.  What is interesting is that while both banks expect a modest walk back of the current economic conditions - especially in housing - while leaving the rest of the statement unchanged, they still expect a 25 bps hike. 

First, here is Morgan Stanley:

And here is Goldman's preview: