FOMC Preview: Here Are The Possible Surprises In Today’s Statement

Today’s FOMC announcement at 2:00pm is expected to be mostly a non-event, and the only incremental information will be what is contained in the updated statement, which comes one month ahead of the Fed’s next expected rate hike in June. There will be no press conference and no update to the summary of economic projections. The statement is expected to incorporate modest changes to reflect recent (mixed) data but see the risks around the meeting are low.

Here is what Wall Street consensus looks like ahead of 2pm:

• The market expect no rate hike at the May meeting; Fed Fund futures are currently pricing in a 65% probability of a June rate hike.
• There is a risk of a small hawkish surprise if the committee indicates they are “looking through” Q1 weakness in growth and inflation.
• A less likely dovish surprise could come from the FOMC emphasizing the decline in inflation.
• It is likely too soon for the committee to update language related to reinvesting balance sheet securities.
• Subsequent Fed speeches by Yellen, Fischer, Williams and Rosengren on Friday will likely provide additional color

Continuing the trend from recent weeks, most Wall Street firms expect the Fed to hike twice more this year despite the recent slowdown in US economic indicators and the near record collapse in the Citi eco surprise index, in June and September and announce balance sheet reduction in December.

With that in mind, below are some observations from Citigroup on the few surprises in the “wording” contained in today’s statement:

FOMC “looking through” weak Q1 may read slightly hawkish

The statement will need to update language regarding inflation, consumption, and job growth – all of which have slowed since the March meeting. The relative hawkishness depends on the extent to which Fed officials attribute the softness to transitory factors.

Consumer spending – Spending slowed significantly in January and February. The consensus view (reflected in March FOMC minutes) is that much of the weakness is transitory owing to (1) less utilities usage due to warm weather and (2) delayed tax refunds.

March: “Household spending has continued to rise moderately”

• Dovish: Household spending moderated.
• Neutral: Household spending moderated but consumer sentiment remains high and real income growth has been robust.
• Hawkish: Household spending moderated largely due to transitory factors

* * *

Inflation – A surprise decline in core prices in March led core PCE to print 1.6% year-on-year undoing most of the progress since 2016. Some update of the inflation language is in order.

March: “Inflation has increased in recent quarters, moving close to the Committee’s 2 percent longer-run objective; excluding energy and food prices, inflation was little changed and continued to run somewhat below 2 percent.”

• Dovish: Inflation is running below the committee’s longer term objective
• Neutral: Inflation has edged lower
• Hawkish: Inflation edged lower in part due to large declines in certain categories.

* * *

Labor market – Going into the March FOMC meeting the economy had added over 200k jobs in each of the previous two months. The last job print of 98K was widely attributed to payback from previously warm weather.

March: “Job gains remained solid and the unemployment rate was little changed in recent months.”

• Neutral: Job gains slowed but the unemployment rate fell further.
• Hawkish: Job gains were solid over the last quarter and the unemployment rate fell further.

* * *

Balance Sheet – Discussion of the timing and details of tapering of reinvestments will likely continue at the May meeting. Assuming tapering is announced in December, the committee may wait until at least June and more likely September before adjusting language in the statement regarding the balance sheet. The minutes to be released on May 24 will likely be more informative on this point.

* * *

And here is Goldman’s full list of exepctations for today’s statement:

1. Constructive comments on full-year growth. Despite the 0.7% increase reported in this morning’s Q1 GDP report, we expect the FOMC statement will continue to sound constructive on growth trends, repeating that “economic activity has been expanding at a moderate pace”, or simply saying that activity “continued to expand.” Underlying growth in the first quarter appears firmer than headline GDP would suggest, and Fed officials including Vice Chair Fischer have argued that growth is likely to be stronger during the remainder of the year. Exhibit 1 summarizes this mixed but generally positive message from growth indicators, which featured some sequential slowing in payrolls growth and our Current Activity Indicator (CAI) but also a drop in the U3 and U6 unemployment rates as well as positive data surprises on net. Relatedly, we expect an adjustment to the statement’s labor market characterization that acknowledges the pronounced drop in the unemployment rate, yet also softens the language around “solid” recent job gains (reflecting the slowdown in March headline payroll growth). We also expect the committee to downgrade its assessment of household spending (from “rise moderately” to “rise modestly”) and for the committee to remove the word “somewhat” in its characterization of firming business investment (i.e. “business investment appears to have firmed.”)

2. Few changes to description of inflation-related data. The previous statement distinguished between headline- and core inflation, a distinction we expect the committee will retain. However, given the pronounced softness in the March core inflation report, the previous statement’s “little changed” characterization of core inflation would seem out of place. Indeed, this morning’s GDP report was consistent with core PCE inflation at 1.6% in March (yoy), down from 1.7% in February. Accordingly, we expect a brief acknowledgement of this softness (i.e. “core inflation slowed somewhat in March”). However, we expect the statement will retain the “continued to run somewhat below 2 percent” wording. Also, the mid-April drop in market-based measures of inflation expectations largely reversed in the final week of the month, with 5Y/5Y breakeven inflation now back at the March levels (2.1%). As a result, we expect no changes to the inflation expectations wording.

3. And unchanged inflation outlook. Despite the March setback, the drop in the March unemployment rate coupled with the committee’s apparent growth optimism suggest little need to modify the inflation outlook. We currently forecast core PCE inflation to reach 2.0% in early 2018, which seems broadly consistent with the March statement’s expectation that “inflation will stabilize around 2 percent over the medium term.” Accordingly, we expect no changes to the inflation outlook paragraph.

4. Unchanged balance of risks and “accommodative” policy description. At its June 2016 meeting, after concerns about the spillovers from Brexit had faded, the FOMC said in its statement: “Near-term risks to the economic outlook have diminished.” The committee upgraded this language again at the September meeting, saying: “Near-term risks to the economic outlook appear roughly balanced.” The qualifiers “near-term” and “roughly” suggest Fed officials are less than fully confident about the outlook. However, we do not expect any changes to this section of the statement, as improving international growth trends are likely weighed against continued geopolitical risks and today’s softer 1Q GDP data. A meaningful upgrade to the balance of risks should be taken as a hawkish signal for the near-term policy outlook, in our view. In terms of the assessment of the stance of current policy, committee members appear to use “accommodative” interchangeably with “modestly” or “moderately accommodative,” and we see little reason to qualify the “accommodative” characterization in next week’s statement – particularly because doing so would likely be interpreted as a dovish shift. 

5. Subtle reference to eventual balance sheet adjustment. We expect a minor change to the balance sheet paragraph, with some sort of allusion to possible eventual reductions. Given the extent of the discussion in the minutes to the March FOMC meeting – as well as several comments by Fed officials over the last month about the Fed’s plans for ending reinvestment – it would seem odd for the statement to omit any reference to the topic. At the same time, committee members will likely want to avoid signaling an imminent policy change. If the committee does edit this section, we expect the wording to be fairly vague and noncommittal. One possibility is that the committee adopts the “gradual and predictable” language from the March minutes as a description of its overarching balance sheet policy. 

6. No explicit mention of fiscal policy. Notwithstanding the Wednesday tax announcement, the committee has gained little incremental clarity on the legislative outlook since the March meeting. Furthermore, the FOMC does not explicitly include the issue in the list of factors it will use to assess appropriate monetary policy (even though fiscal stimulus may be the single most important source of uncertainty for the economic outlook this year and next year.) The committee has mentioned fiscal policy in past statements, but only after-the-fact in recent years. For example, statements in 2009 referred to “fiscal and monetary stimulus”, while those in 2013 said that “fiscal policy is restraining economic growth”. A similar approach seems likely this time around, with fiscal policy only discussed in the statement after legislation begins to affect the economy. 

7. No dissents. Minneapolis Fed President Neel Kashkari dissented against the March hike, but dovish dissents seem very unlikely given our expectation that rates will be left unchanged. We also do not expect any hawkish dissents, in part because a pause at this meeting would still be consistent with as many as four hikes over the course of 2017 that could be achieved in the three remaining press conference meetings.