This Is What It Looks Like When Doves Fly

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Prior to this week's FOMC meeting, here are three things we said to watch for: 1) the word "patient" would be stricken from the forward guidance around the path of the Fed funds rate; 2) the FOMC's central tendency estimate of "full employment" would be lowered; 3) the "dot plot" - the chart showing individual Committee members' expectations of the appropriate path of the funds rate - would be softened, showing a less aggressive course of funds rate hikes after the initial increase.

Here is what happened at this week's FOMC meeting: 1) the word "patient" was stricken from the forward guidance; 2) the central tendency estimate of the unemployment rate consistent with "full employment" was lowered; 3) the "dot plot" was softened.

Nonetheless, we still end up somewhat surprised at the extent to which the Committee softened not only their language but also the projected path of the Fed funds rate. First, the current view of the economy was downgraded, with the post meeting statement noting economic growth has "moderated somewhat" compared to January when the economy was said to be expanding at "a solid pace." In and of itself, this is not surprising, as anyone tracking the high frequency data is aware. What is surprising, though, is the Committee did not cite transitory factors, such as the West Coast port strike or harsh winter weather across much of the U.S. in February. The statement also noted export growth has weakened, though offering no views on the extent to the relative contributions of the port strike, weaker global growth, or the stronger U.S. dollar. All in all, though, the central tendency forecast for real GDP growth is slightly lower but not meaningfully different than that offered in December, and in her press conference Chairwoman Yellen noted a weaker net export position was the main reason behind the downgrade there is in the growth forecast.

The most surprising element of the meeting, however, is the extent to which the "dot chart" was softened from that issued in December. The median year-end 2015 level of the median expectation of the midpoint of the funds rate target is 0.625 percent as of today's meeting, at the December meeting the median was 1.125 percent. This is consistent with a later liftoff in the funds rate, i.e., our long-held call for September now looks more likely than June. For year-end 2016 the median expectation of the midpoint of the funds rate target is now 1.875 percent, down from 2.50 percent in December. These lower year-end medians are far more consistent with where the markets have been for some time but below where the FOMC has been.

As to the change in forward guidance, patient is gone and April is "unlikely" as for the liftoff of the funds rate, per the post meeting statement. But, as Dr. Yellen stated in her press conference "just because we've removed the word ‘patient' doesn't mean we're going to be impatient." The Committee will, however, be data dependent, as stressed by Dr. Yellen. She noted at present June cannot be ruled out as for the initial liftoff, but more generally the initial hike could be warranted at any meeting after April depending on the evolution of the incoming data. Specifically, the Committee notes they will need to see "further improvement in the labor market" and they will need to be "reasonably confident inflation will move back to the 2.0 percent objective over the medium term." Clearly the Committee sees current low readings on headline inflation as reflecting transitory effects of low energy prices that will, over time, wash out of the data. We will note that with the central tendency range for full employment being marked down to 5.0-5.2 percent from the 5.2-5.5 percent range in earlier rounds of projections the Committee is again reinforcing their collective view the current headline unemployment rate of 5.5 percent is understating the degree of labor market slack. Dr. Yellen reinforced this point at her press conference, citing the lack of upward pressure on earnings growth, elevated numbers of those working part-time for economic reasons, and elevated numbers of "discouraged workers" as evidence that, though diminishing, labor market slack remains elevated.

Going into this week's meeting, we said the main task of the FOMC would be to strike the word "patient" from their forward guidance without rattling the financial markets into thinking an imminent rate hike was upon us, to be followed with a series of successive hikes. Judging from the post-meeting reaction in the markets - stock prices higher, long-term yields lower - we'd say the FOMC succeeded. This, apparently, is what it looks like when doves fly (with all due apologies to Prince, or however he refers to himself these days, for being inspired by but not exactly reproducing his lyrics).

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