Fed: 25bps hike is in the pipe - Natixis

Another 25bps hike is in the pipe for today’s FOMC meeting but uncertainty is growing for the future course of monetary policy in the second part of the year, explains Thomas Julien, Research Analyst at Natixis.

Key Quotes

“With the Fed’s goals going in opposite directions (lower inflation and lower unemployment rate), J. Yellen’s message will be key in determining whether or not the central bank will be eager to pursue with its initial plan for the year (i.e. another hike in September and balance sheet normalization announcement in December).”

“The statement (June vs. May): 25bps hike

We expect the Fed to acknowledge that incoming data are consistent with economic activity picking up with further strengthening in labor market conditions: the pace of job gains can still be described as “solid” while the unemployment rate is 0.2pts lower compared to where it was when the Fed last met in May. However, we expect a slightly more dovish wording on inflation as the yearly growth rate of the core PCE deflator has moved lower in the intermeeting period (from 1.8% to 1.5%) while inflation expectations are still subdued. The outlook should remain broadly unchanged as well as the description of near-term risks (“roughly balanced”).  

Without much surprise, the Fed will announce another 25pbs hike (with the target range of the Fed Funds rate reaching 1.0%-1.25%)  in the 3rd paragraph of the statement and no one is expected to dissent from the decision.” 

“The Summary of Economic Projections (June vs. March): unchanged dots

SEP: The median of growth forecasts for 2017-18 should remain unchanged. Yet, both the unemployment rate and inflation forecasts will have to be revised downward over the forecast horizon. The long term estimate of the unemployment rate may also see a 0.1pt decline to 4.6%. 

The dots: we expect the dots to remain broadly unchanged. That being said, there may be a chance for the median of the dots to move higher in 2018 just as the result of Tarullo’s departure. The dots plot will remain consistent with 1 more hike in 2017 (after the June move) and 3 in 2018.” 

“The post-meeting press conference: what will be the next move?

Given the conflicting evolution of inflation and labor market indicators recently, the outlook for monetary policy in H2 2017 has become more uncertain. The market is still pricing a 50% chance of a 3rd hike in 2017 but with a lower probability that the next move will be September. Meanwhile some analysts now believe that balance sheet normalization could come earlier (in September) in order to give the Fed some time before hiking again in December. Therefore, Chair Yellen’s post statement remarks may be helpful in determining what the next move will be (hike or BS normalization). Our central scenario remains that the Fed will hike one more time in September before announcing a BS normalization plan in December. It is worth noting that if the Fed wants to start normalizing its BS in September it probably has to update its Policy Normalization Principles and Plans as soon as on Wednesday.”