Sunday, September 13, 2015

FOMC Preview and Review of Projections

by Bill McBride on 9/13/2015 12:14:00 PM

Analysts are split on whether the FOMC will raise the Fed Funds rate this week.   It could go either way.

Those arguing the FOMC will probably wait until December (or until 2016) point to inflation below target, market based financial tightening (stronger dollar, wider credit spreads), global economic weaknesses, and recent stock market volatility.

Those arguing the FOMC will probably raise rates this week point to "some further improvement" in the labor market, and that the forces holding down inflation are dissipating.

Note: It is a different question if the Fed "should" raise rates in September, as opposed to "will" the Fed raise rates.  Clearly the risks are asymmetrical (hiking too soon poses much larger risks than waiting too long), and that argues for waiting a little longer.

For review, here is the key sentence in the July FOMC statement:

"The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
Since that statement, the economy added 245 thousand jobs in July and 173 thousand jobs in August (and frequently August is revised up).  The unemployment rate declined from 5.3% in June to 5.1% in August.  This is probably the "some further improvement" in the labor market that the FOMC mentioned in the July statement.

So the focus at the FOMC meeting will probably be on inflation.  Is the FOMC "reasonably confident that inflation will move back to its 2 percent objective over the medium term" (emphasis added).

Fed Vice Chairman Stanley Fischer said two weeks ago:
As I have discussed, given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further. While some effects of the rise in the dollar may be spread over time, some of the effects on inflation are likely already starting to fade. The same is true for last year's sharp fall in oil prices, though the further declines we have seen this summer have yet to fully show through to the consumer level. And slack in the labor market has continued to diminish, so the downward pressure on inflation from that channel should be diminishing as well.
emphasis added
Although inflation may be low over the next few months (lower oil prices), it sounds like Fischer is "reasonably confident" that inflation will move higher in the "medium term".

What about the revisions to the FOMC projections?  (See below)  Projections for 2015 GDP will probably be revised up, the unemployment rate revised lower, and core inflation revised up slightly.  

My view: Based on the FOMC's previous statement, and the likely revisions to the FOMC projections, and Fischer's views on inflation, it seems likely the FOMC will raise rates this week.

Here are the June projections.  Since the release of those projections, Q1 GDP was revised up from -0.7% annualized to +0.6% annualized. And Q2 GDP was reported at 3.7% (and will probably be revised up a little more).

So it seems likely projections for 2015 GDP will be revised up.

GDP projections of Federal Reserve Governors and Reserve Bank presidents
Change in
Real GDP1
201520162017
Jun 2015 1.8 to 2.02.4 to 2.72.1 to 2.5
Mar 2015 2.3 to 2.72.3 to 2.72.0 to 2.5
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 5.1% in August, so the unemployment rate projection for Q4 2015 will be revised lower. 

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents
Unemployment
Rate2
201520162017
Jun 2015 5.2 to 5.34.9 to 5.14.9 to 5.1
Mar 2015 5.0 to 5.24.9 to 5.14.8 to 5.1
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

As of July, PCE inflation was up only 0.3% from July 2014.   However, PCE inflation has been running at a 2.2% annualized rate over the last 6 months.  At that rate, PCE inflation will be up to 0.9% year-over-year in Q4.

On the other hand, oil prices have declined a little since July, and, as a result, PCE inflation could move down some more in August.  Overall PCE inflation projections will probably be mostly unrevised for 2015, and will be well below the FOMC's 2% target.

Inflation projections of Federal Reserve Governors and Reserve Bank presidents
PCE
Inflation1
201520162017
Jun 2015  0.6 to 0.81.6 to 1.91.9 to 2.0
Mar 2015  0.6 to 0.81.7 to 1.91.9 to 2.0

PCE core inflation was up only 1.2% in July year-over-year.  However core PCE inflation has been running at a 1.7% annualized rate over the last 6 months.  Based on the last 6 months, it appears 2015 projections for core PCE will be revised up slightly.

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents
Core
Inflation1
201520162017
Jun 2015 1.3 to 1.41.6 to 1.91.9 to 2.0
Mar 2015 1.3 to 1.41.5 to 1.91.8 to 2.0