Patient in all but words

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On March 18, the Federal Open Markets Committee (FOMC) statement came in firmly in line with market expectations, with the Committee choosing to drop the reference to a “patient” approach to beginning policy normalization and acknowledging recent softness in data. In contrast, the Summary of Economic Projections contained a number of surprises. According to the Projections, the Committee now sees a more sluggish path of inflation through the end of 2016 and more labor market slack than previously projected. On inflation, the central tendency of Committee participants now points to core PCE inflation of 1.3 to 1.4 % at the end of this year, down from 1.5 to 1.8 % in the December projections. So essentially, the FOMC does not expect any increase in inflation from current levels until next year. The central tendency for end-2016 Core PCE inflation also came down a bit, to a range of 1.5 to 1.9 %. Although the 2017 inflation projections remain close to 2 %, these are not projections that suggest reasonable confidence in hitting the inflation mandate over the medium term.

The downward revisions to the projections for the longer-run unemployment rate, which can largely be thought of as NAIRU (non-accelerating inflation rate of unemployment), are no less significant. Most Committee members now estimate the longer-run unemployment rate at 5.0 to 5.2 %, down from 5.2 to 5.5 % in the December projections. This is the largest downward revision to the NAIRU estimate since the Federal Reserve began publishing its projection materials at the time of FOMC meetings four years ago, and mechanically suggests that Committee members see no diminishment in labor market slack in recent months. But Chair Yellen had an even less positive interpretation of the lower NAIRU projection in her press conference, as she commented that Committee members now appear to see more slack in the economy. I interpret the Chair’s repeated references in the press briefing to the lower longer-run unemployment projection as an indication of an active Committee discussion around the reasons for the lack of meaningful wage pressures in the labor market, leading to the conclusion that the labor market must still be a decent ways away from full employment.

Given projections that indicate the Committee has a longer road ahead to achieve its inflation and labor market objectives, it comes as no surprise that the Committee now expects a shallower path of policy rate increases. The so-called “dot plot” now registers a median projected policy rate at year-end of 5/8%, consistent with an IOER (Interest on excess reserves) rate of 75 basis points. This median IOER projection is fifty basis points lower than the prior projection round, and the path of rate increases in 2016 and 2017 shifted down by similar amounts. The year-end projection suggests just two 25 basis point rate increases this year, and implies policy firming beginning no sooner than September. In fact, the low end of the central tendency of the projections, which I view as more reflective of the views of core Committee members, suggests just one rate increase this year. So barring a near-term upside inflation surprise, I have shifted my modal expectations for liftoff to September, but take today’s communications as suggesting meaningful odds that lift-off could occur even later.

Steven Friedman

Senior Investment Strategist

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