Jay Powell is widely expected to preside over his first interest rate increase as Federal Reserve chair on Wednesday. However, the focus for many investors is less on this week's likely quarter-point move and more on what happens next.
The central bank has been sending more hawkish signals this year as officials suggest they will not stand by and let the economy overheat given the buoyant labour market and massive fiscal stimulus being delivered by Congress.
The question is how Mr Powell and his colleagues deliver their prognosis without spooking the markets. There are still mixed feelings within the Fed about pushing through a series of rate rises at a time when inflation remains doggedly below the central bank’s official target.
What will happen at the meeting?
The Fed is likely to lift rates for the first time in 2018, adding a quarter point to the federal funds target range, which stands at 1.25 per cent to 1.5 per cent. Traders are fully expecting the move: according to figures from CME Group, the odds being put on an increase by the markets are more than 90 per cent. No dissents seem likely, and the programme to gradually shrink the Fed’s balance sheet is set to continue uninterrupted.
The market’s attention will be on accompanying economic forecasts which show what officials are thinking about the economic outlook and the right level of interest rates over the coming years. Attention will also be on the language in the Fed’s post-meeting statement, issued at 2pm US eastern time, and on Mr Powell’s first press conference as Fed chairman.
What will the forecasts show?
The Fed in December predicted gross domestic product growth of 2.5 per cent this year, 2.1 per cent in 2019 and 2 per cent in 2020, with unemployment dipping to 3.9 per cent this year and next before returning to 4 per cent. The big change since then is the arrival of the full details of the government’s $1.5tn tax cut, plus a congressional deal to lift caps on federal discretionary spending for the next couple of years.
US central bankers have made no secret of the magnitude of those changes. Lael Brainard, a Fed governor, said in a recent speech that the tax legislation alone could add as much as a half percentage point to GDP growth this year and next. On top of that, the congressional spending deal should raise federal spending by 0.4 per cent of GDP in each of the next two years, she said.
Countering that is the prospect of a sluggish start to the year growth-wise, with the Atlanta Fed predicting growth of 1.8 per cent in the first quarter. But there is a good chance the Fed’s median growth, inflation and unemployment forecasts see upgrades. This has implications for monetary policy, as Mr Powell suggested in a congressional hearing last month.
What about the interest rate outlook?
The Fed’s median projection in December was for three rate rises this year, followed by another two in 2019. By 2020 it was predicting rates would reach 3.1 per cent, above the estimate for rates over the longer term, which stood at 2.8 per cent. One of the big questions is whether the 2018 median forecast could move to four rate rises; analysts say it would take four officials to shift their position upwards for that to happen, which is by no means certain.
Forecasts in 2019 or 2020 could also move, and there is speculation that the Fed lifts its estimate for the longer-run interest rate. This would reflect a more optimistic view of the economy’s performance and of the interest rate needed to keep it on an even keel, taking on board stimulative fiscal policy and improved global growth.
The messaging around these forecasts will be carefully nuanced. The Fed wants to stick with its "gradual" approach to rate rises, and its new chairman will be keen to stress continuity with the cautious approach adopted by his predecessor Janet Yellen. The Fed has presided over years of below-target inflation, and some officials want to see clearer evidence that price growth is on the right track before moving.
Further complicating the outlook is the possibility that the short-term boost from fiscal policy subsides sharply early in the next decade, reducing the fuel behind the recovery.
What else is on the agenda?
The Fed will update the language in its post-meeting statement when this is released at 2pm. Mr Powell will then face the media from 2.30pm, with questioners likely seeking his views on topics ranging from a possible trade war to the risks of an overheating financial market.
Mr Powell has emphasised his appetite for further transparency, so he could be asked if he wants to hold press conferences more often. Such a move would be significant, because markets would view it as freeing the Fed’s hand to move rates more regularly. The Fed can change policy whenever it chooses, but it has tended to confine big monetary policy announcements to the four meetings a year when the chair addresses the press.
– Copyright The Financial Times Limited 2018
