FOMC Minutes: Behind the third dot - Rabobank

In view of the Philip Marey, Senior US Strategist at Rabobank, the minutes of the FOMC meeting of December 13-14 showed how dependent the Fed’s rate outlook has become on the timing and impact of the economic policies of the incoming Trump administration.

Key Quotes

“In their discussion of their economic forecasts, participants emphasized their considerable uncertainty about the timing, size, and composition of any future fiscal and other economic policy initiatives as well as about how those polices might affect the economy. Several participants pointed out that, depending on the mix of tax, spending, regulatory, and other possible policy changes, economic growth might turn out to be faster or slower than they currently anticipated. However, almost all also indicated that the upside risks to their forecasts for economic growth had increased as a result of prospects for more expansionary fiscal policies in coming years.”

“In fact, about half of the participants incorporated an assumption of more expansionary fiscal policy in their forecasts. This explains why the December dot plot implied 3 rate hikes in 2017, instead of the 2 hikes in the September projections. However, many participants underscored the need to continue to weigh other risks and uncertainties attending the economic outlook. Among the downside risks cited were the possibility of additional appreciation of the dollar, financial vulnerabilities in some foreign economies, and the proximity of the federal funds rate to the effective lower bound.”

“For some participants, the greater upside risks to economic growth, the upward movement in inflation compensation over recent months, or the possibility of further increases in oil prices had increased the upside risks to their inflation forecasts. What’s more, many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures. However, several others pointed out that a further rise in the dollar might continue to hold down inflation. And with inflation still below the Committee’s 2 percent objective, it was noted that downside risks to inflation remained and that a moderate undershooting of the longer-run normal unemployment rate could help return inflation to 2 percent.”

“Despite the Fed’s upward shift in the dot plot, we are skeptical of 3 hikes in 2017. Keep in mind that they expected 4 hikes for 2016 back in December 2015 and we have seen only 1. There are several reasons for our skepticism. First, the implementation lag of infrastructure spending can be considerable. Finding shovel ready projects can be a challenge. Second, the impact of infrastructure spending on GDP growth may also take time. Note that the $305bn highway bill of December 2015 has yet to have a positive impact on GDP growth. Third, the positive impact of the fiscal impulse may be mitigated by the negative fall-out from Trump’s trade policies. Finally, the voting members of the FOMC will be more dovish in 2017 than in 2016, with the three hawkish September dissenters George, Mester and Rosengren losing their voting rights.”

“Therefore, we still expect only one rate hike in 2017, most likely in December. If the fiscal policy impulse hits the economy sooner than we expect, and with more impact, the risks to our forecast lie to the upside. In contrast, if the fiscal impulse disappoints in terms of timing and size, or if trade conflicts bring substantial damage to the US economy, the risks lie to the downside.”