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Sunday, March 14, 2021

FOMC Preview

by Calculated Risk on 3/14/2021 10:53:00 AM

Expectations are there will be no change to rate policy when the FOMC meets on Tuesday and Wednesday this week, but that the FOMC will upgrade their outlook.

Here are some comments from Merrill Lynch economists:

"The FOMC meeting on the 17th will be one of the most critical events for the Fed in some time. We believe Fed Chair Powell will have to strike the right balance between a more upbeat assessment of the outlook and the asymmetric FAIT [flexible average inflation targeting] reaction function. The result will be an acknowledgement that liftoff is earlier than believed back in mid-December but that it is still later than markets currently believe. ...

[W]e expect the latest projections to show material upward revisions from the December SEP. We expect growth this year to be revised by at least 1.5ppt to a range of 5.7% - 6.0% 4Q/4Q reflecting the effects of the American Rescue Plan and the improving outlook on the virus situation. ... The unemployment rate is likely to be revised down across the forecast horizon, showing a faster reduction in labor market slack. However, it will be relatively modest compared to the upgrade in growth, suggesting a stronger labor force recovery. This will in turn support modest upward revisions to core PCE inflation such that the 2023 forecast will show an overshoot of the Fed’s target. These ingredients — the unemployment rate at pre-pandemic levels and inflation modestly above target – will be enough to warrant one hike by the Fed in 2023."
emphasis added
For review, below are the December FOMC projections.

GDP projections of Federal Reserve Governors and Reserve Bank presidents, Change in Real GDP1
Projection Date2020202120222023
Dec 2020-2.5 to -2.23.7 to 5.03.0 to 3.52.2 to 2.7
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.

Note that GDP decreased 2.4% Q4-over-Q4 in Q4 2020.   That was close to the bottom of the December projections.  GDP would have to increase 10.4% in Q1 to return to the pre-recession peak in Q4 2019 (unlikely).

Many forecasters are optimistic about a very strong recovery in 2021, for example, from Goldman Sachs economists this weekend:
"In light of the larger fiscal package just enacted, we now expect slightly higher GDP growth of +6% / +11% / +8.5% / +6.5% in 2021Q1-Q4 which implies +7.0% in 2021 on a full-year basis (vs. +5.5% consensus) and +8.0% on a Q4/Q4 basis (vs. +6.0% consensus)."
We should expect a significant upgrade to the GDP forecast for 2021 and 2022.  

But there are still downside risks for 2021. For example, if there are vaccine resistant mutations to the virus, or it takes longer than expected to achieve "herd immunity". The pandemic remains a huge unknown.

The unemployment rate was at 6.2% in February.

Note that the unemployment rate doesn't remotely capture the economic damage to the labor market.  Not only are there 10 million people unemployed, but 4.2 million people have left the labor force since January 2020.  And millions more are being supported by various provisions of the various disaster relief acts.

Merrill's view is the unemployment rate forecasts will be revised down, but "will be relatively modest compared to the upgrade in growth". The decline in the unemployment rate depends on both job growth, and the participation rate. A strong labor market will probably encourage people to return to the labor force, and the improvements in the unemployment rate might be slower than some expect.

Unemployment projections of Federal Reserve Governors and Reserve Bank presidents, Unemployment Rate2
Projection Date2020202120222023
Dec 20206.7 to 6.84.7 to 5.43.8 to 4.63.5 to 4.3
2 Projections for the unemployment rate are for the average civilian unemployment rate in the fourth quarter of the year indicated.

As of January 2020, PCE inflation was up 1.5% from January 2020.    

Inflation projections of Federal Reserve Governors and Reserve Bank presidents, PCE Inflation1
Projection Date2020202120222023
Dec 20201.21.7 to 1.91.8 to 2.01.9 to 2.1

PCE core inflation was up 1.5% in January year-over-year. 

Core Inflation projections of Federal Reserve Governors and Reserve Bank presidents, Core Inflation1
Projection Date2020202120222023
Dec 20201.41.7 to 1.81.8 to 2.01.9 to 2.1

My guess is core PCE inflation (year-over-year) will increase in 2021 (from the current 1.5%), but I think too much inflation will NOT be a concern in 2021. Since we saw negative MoM PCE and core PCE readings in March and April, we should ignore a jump in YoY inflation in March, April and May.

It will be interesting to see if the FOMC projects an overshoot in inflation in 2022 or 2023.