Friday, December 12, 2014

Merrill and Nomura: FOMC Preview

by Bill McBride on 12/12/2014 02:10:00 PM

From Lewis Alexander et al at Nomura:

We expect the December FOMC meeting to give us additional insight into the future path of monetary policy. We will receive another round of FOMC forecasts for the first time since September, which will incorporate significant new data. The drop in energy prices will likely lead the FOMC to lower its inflation forecasts, and the Committee will likely have to lower its unemployment rate forecasts, due to the faster-than-expected declines in the unemployment rate.

Moreover, we expect the FOMC to make changes to its forward guidance. Given recent Fed speak and improvement in US economic momentum, we now think it is more likely than not that the FOMC will drop the “considerable time” language in its December policy statement. However, we expect them to replace this with some statement that suggests that rate hikes are not imminent.
From Michael Hanson at Merrill Lynch:
Next week’s FOMC meeting will feature updated forecasts (including the dot plot) and a press conference from Fed Chair Janet Yellen. But most market discussion of late has focused on the “considerable time” phrase: will it stay or will it go? Our base case is that the Fed will replace it with language emphasizing patience, but it is a close call versus keeping the current text. Whether or not that language is changed, we expect Chair Janet Yellen to signal a patient and gradual evolution of policy in a data-dependent context in her post-meeting press conference. The Fed likely wants to gradually guide the markets toward liftoff, not shock them.
...
What is almost certain is that the Fed will not simply drop “considerable time” without any substitute. ... as New York Fed President Bill Dudley reiterated this past week, to be a bit too late than to be too early. Additional reasons for patience include the limited set of policy options should the Fed have to ease further, as well as the hit to credibility of having to soon reverse a hiking cycle. We expect patience will be a main message in the December FOMC meeting and in Yellen’s post-meeting remarks.
Here are the most recent FOMC projections.  It looks like GDP will be revised up for 2014 (and possibly for 2015).

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in
Real GDP1
2014201520162017
Sept 2014 Meeting Projections2.0 to 2.22.6 to 3.02.6 to 2.92.3 to 2.5
June 2014 Meeting Projections2.1 to 2.33.0 to 3.22.5 to 3.0n.a.
1 Projections of change in real GDP and inflation are from the fourth quarter of the previous year to the fourth quarter of the year indicated.

The unemployment rate was at 5.8% in both October and November, so the unemployment rate projection for Q4 2014 will be lowered again.

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents
Unemployment
Rate2
2014201520162017
Sept 2014 Meeting Projections5.9 to 6.05.4 to 5.65.1 to 5.44.9 to 5.3
June 2014 Meeting Projections6.0 to 6.15.4 to 5.75.1 to 5.5n.a.
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

As of October, PCE inflation was up 1.4% from October 2013, and core inflation was up 1.6%.  Headline inflation will be even lower in November and December with the decline in oil prices.  It seems likely the FOMC will lower their inflation projections (or move to the lower end of the September range).  The key will be the inflation projections for next year.

Inflation projections of Federal Reserve Governors and Reserve Bank presidents
PCE
Inflation1
2014201520162017
Sept 2014 Meeting Projections1.5 to 1.71.6 to 1.91.7 to 2.01.9 to 2.0
June 2014 Meeting Projections1.5 to 1.71.5 to 2.01.6 to 2.0n.a.

Here are the FOMC's recent core inflation projections:

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents
Core
Inflation1
2014201520162017
Sept 2014 Meeting Projections1.5 to 1.61.6 to 1.91.8 to 2.01.9 to 2.0
June 2014 Meeting Projections1.5 to 1.61.6 to 2.01.7 to 2.0n.a.