The Federal Reserve’s ultra-cautious exit from super-easy monetary policy is likely to accelerate on Wednesday as the US central bank lifts short-term interest rates by another quarter point. What are the key signals to watch for as the Federal Open Market Committee meets?
Policy change
It would now be a significant shock if the US central bank did not lift the target range for the federal funds rate by another quarter point from the current 0.5 per cent to 0.75 per cent.
The chances of a move were seen by markets at around 95 per cent going into the meeting, according to a CME Group analysis of futures prices. So the issue for investors is judging whether the next move could come as soon as June and whether there is the possibility of four increases this year, rather than the three predicted in December. Either way, the Fed is still likely to characterise its rate-raising plans as “gradual”.
How does the Fed see the economy?
The post-meeting statement seems likely to reaffirm the continued strengthening of the jobs market and moderate growth in the overall economy. It might acknowledge that the headline measure of inflation tracked by the Federal Open Market Committee is now at 1.9 per cent year-on-year, just a notch below the Fed’s target, although core inflation still remains a little further behind.
One key question is whether there is any further change to language on the risks of positive or negative developments hitting the economy. Right now, the risks are seen as “roughly balanced”, pointing to a fair degree of sangfroid.
How about the Fed’s forecasts?
The Fed will update growth, inflation and unemployment forecasts last released in November. Crucially, it will also produce a dot-plot showing individual policymakers’ predictions for the federal funds rate.
As of December the median prediction was for three increases in 2017, but if four or more officials lift their outlooks to four increases it would be enough to shift the median up a notch. Janet Yellen, the Fed chair, signalled in her most recent speech that she was comfortable with the three-increase forecast released in December.
In a tweak to gratify central banking aficionados, the Fed has said it will add so-called fan charts to its economic projections illustrating the uncertainty around those forecasts. These will appear with minutes to this week’s meeting released on April 5th.
What will happen to the Fed balance sheet?
The Fed’s balance sheet has swollen to $4.5 trillion via its crisis-era interventions, which included purchases of vast quantities of government bonds and mortgage-backed securities.
Recently officials have started openly discussing the possibility of reducing the size of its holdings. The Fed seems likely to keep existing language in its statement pledging to keep reinvesting the proceeds of maturing securities in its portfolio until normalisation of rates is “well under way”.
However, Ms Yellen is likely to face questions in a post-meeting press conference starting at 2.30pm EDT about when and how the Fed could start shrinking its balance sheet. How she handles those questions is very market sensitive. The Fed in 2013 managed to discombobulate financial markets with a miscued signal regarding its balance sheet strategy.
– Copyright The Financial Times Limited 2017
