The FOMC is in the process of re-evaluating its economic and policy outlook, and is also reviewing its policy framework. Nothing about that process is moving fast—the Fed is being patient in assessing the economic and financial environment—so the March 19-20 meeting will deliver no immediate changes. It is, on the other hand, likely to produce a good bit of policy news.
The policy statement always reflects the current state of the economy, as well as the Fed’s view of the outlook. The wording to describe the current state of the economy will be softened. Output in Q1 is unlikely to be described as “rising at a solid rate,” nor is household spending likely to be described as “grow[ing] strongly.” The big question is whether the statement confidently assumes the Q1 slowdown was temporary or shows concern it may persist. We assume “temporary” is the right answer for now. The labor market may still be described as “strengthening,” but probably with a qualifier such as “on balance” to reflect weak job growth in February.
The forward-looking text about the economy is likely to repeat that the Committee views “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes.” Policy guidance will remain that the Committee will “be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate…”
The Summary of Economic Projections
Our assumptions about the SEP are reflected in Figure 1. To be clear, we expect the Fed’s forecast to diverge from our own when it comes to the funds rate path and real GDP growth. We are a bit more optimistic than we think the Fed will be.
There is some chance that the estimate for the longer-run fed funds rate or unemployment rate will come down. There has been a slow drift lower for both estimates since mid-2015, when the SEP first began to report longer-run funds rate estimates. With the inflation rate struggling to hold near the Fed’s 2.0% target despite an unemployment rate well below the Fed’s current “neutral“ jobless rate estimate, some members may lower their employment estimates. The longer-run unemployment rate estimate has fallen since mid-2015 from 5.1% to 4.4%. Plug that change into a standard Taylor rule and the decline in the estimate of the neutral fed funds rate target that pops out is 0.7 ppt, exactly the change in the FOMC’s long-run funds rate estimate over that same period. The Fed is a Taylor-rule central bank, though only informally so.
Figure 2: SEP Estimates of the Neutral Unemployment and Real Fed Funds Rates over Time
Source: FOMC, Continuum Economics
Powell’s Press Conference
“Patience” as policy guidance means not only that the Fed will not alter its rate stance very soon, but also that Powell will not change his story about the policy outlook very often. He will be asked about interest rates, but he will not change what he says about the rate path. He will be asked about balance sheet run-off, and here there may be some fresh news. Powell has said he would not announce the end of balance sheet run-off at the March FOMC meeting, but would soon after. He may be able to fill in a few blanks about the balance sheet, even if the Fed is not yet ready to tell the world about the target size of reserve holdings or when run-off will end.