FOMC Preview – Fed’s Rate Hike A Done Deal, Focus Turned to Forward Guidance

Central banks news

A rate hike of +25 bps at the upcoming FOMC meeting is a done deal as the market has for months priced in over 90% chance of its occurrence. Recent macroeconomic developments indicate such rate hike is totally justified. The focuses are on the forward guidance on the future path of normalization and the updated economic projections. We expect the members to upgrade the economic growth and inflation assessment. It is also prudent to make some changed on the forward guidance, to illustrate that the rate- hike process since the end of 2015 has taken the policy more closely to “neutral” than years ago.

The second estimate shows that GDP expanded +2.2% in 1Q18. Growth, however, is expected to accelerate later in the year, as the impact of the tax reform plan becomes more evident. For the first quarter, the government estimated that after-tax corporate profits surged +5.9%, compared with +1.7% in 4Q17. The outlook for the second quarter is upbeat. For instance, the Atlanta Fed projects that growth would soar to +4.6% in 2Q18, more than doubling the growth rate in the prior quarter.

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Strong economic activity has continued to absorb spare capacity remaining in the market. The unemployment rate slipped further to 3.8% in May, further below the long-term rate of +4.6%. Nonfarm payrolls increased +223K in May, the biggest addition in 3 months and beating consensus of a +118K increase. Wage growth is on track to improve, albeit gradually. Inflation stands sustainably above +2%.

Scheduled for release on June 12, headline CPI is expected to accelerate to +2.8% y/y in May from +2.5% a month ago. Core CPI probably improved to +2.2% y/y, from April’s +2.1%. Meanwhile, PCE, the Fed’s preferred gauge of inflation has steadied at about +2% over the past two months. Meanwhile, consumer spending, investment, and trade data have all improved since the last meeting. We expect the staff economic projections to be upgraded slightly, revising higher GDP growth, lower unemployment rate, and higher headline PCE inflation for this year.

With a June rate hike fully priced in, the focus is on the future monetary policy path. The median dot plot might show totally 4 rate hikes, compared with 3 previously, this year. The forward guidance, stating that the fed funds rate “is likely to remain, for some time, below levels that are expected to prevail in the longer run”, has not been changed since the first post-global finance crisis rate hike in December 2015. We believe this should be amended to illustrate that the policy rate is getting closer to neutral after a number of rate hikes. Moreover, the description that the current level policy rate remains “accommodative” might warrant change for the above-mentioned reason.

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