No Rate Hike In March?

Today the Fed had its February meeting. There was almost no expectation for a rate hike today. The Fed met those expectations in a dovish manner. There were hopes that the Fed would boost the expectations for the possibility of a rate hike in March (have a hawkish tone). Heading into the meeting, there was a 20.3% chance of a rake hike in March. If the Fed would’ve been strong in its hawkish language, it would have been able to increase those odds. If the probability of a rate hike heading into the March meeting was in the 30%-50% range, it would be considered a ‘live’ meeting with a low chance of any action.

This understanding of Fed policy works on classifying rate hikes under 3 categories. There is a meeting with no rate hike, a ‘live’ meeting which hints at a rate hike, but doesn’t deliver, and a meeting with a rate hike. This decision today insures the March meeting will not be a ‘live’ meeting. This means the March meeting will set up May to be a ‘live’ meeting with the June meeting being the first hike of the year. There’s only 4 meetings left in the year after that, which means the Fed would need to quicken its pace and do 2 hikes in the 2nd half of the year to meet its 3 rate hike guidance it had heading into the year.

With today’s announcement, the Fed has made the March meeting not ‘live’. I will get into the specifics of how this happened, but you only need to look at what the market is pricing in to see this change. As I said, the chance of a rate hike in March was 20.3% before the meeting. It fell to 17.7% after the announcement which means it will likely be a repeat of today’s decision. Steve Liesman mentioned the Fed could try to do media appearances to make March a ‘live’ meeting, but the Fed already has strong economic data at its disposal, so I don’t see what point it can make to the market in the next few weeks to claim it has changed its mind. If the data was bad going into the meeting and then improved in the next few weeks, then the probability would increase, but that’s not the case. The Fed acknowledged business sentiment has improved and it has seen the good ADP and ISM reports.

What I am getting at is the dovish tone of this meeting surprised those who took the Fed’s word at face value and expected three rate hikes this year. If you break the year down in half, the Fed is now, at most, going to hike once in the first half. That would be slower than the pace needed for 3 hikes. However, I am not surprised by this meeting because I have been forecasting zero rate hikes this year. I think the Fed is ‘kicking the can down the road’ like it has done in the past few years. There needs to be consistent economic data and a clear fiscal policy for the Fed to raise rates. I don’t think the economy will have 4% GDP growth this year since most of Trump’s policies won’t go into effect until 2018. If the economy accelerates, I’ll raise my expectations to 1-2 rate hikes this year.

The entire statement was short. It was only 499 words which was the shortest FOMC statement since August 2012. As I expected, the Fed wanted to punt on this meeting, making it as quiet as possible to wait until it has more clarity on the fiscal policy front. The reason why this is dovish is because the data is positive. Not describing the good data is dovish. If the data was negative, this type of statement would have been considered hawkish.

Now I will go through the changes which I have shown in the image below. The first few changes recognize the fact that the labor market, economic activity, and household spending has remained solid over a more extended period of time. I consider this to be neutral when it should have been hawkish because the data in the past few months has improved significantly. The one line which was a substantive addition to the statement was about how business and consumer sentiment has improved as of late. The size of the jumps in these sentiment indicators should have been highlighted more if the goal was to accurately portray the economy.

If I was to summarize the economy, I’d say it shows signs of accelerating in the first quarter due to extraordinary sentiment improvements. The Fed downplayed this which is why the market is considering it dovish. Goldman Sachs says it is maintaining its odds of a March rate hike at 35%. At best this statement didn’t change some opinions. Danielle DiMartino says the Fed squandered its opportunity to move the market towards expecting a rate hike sooner.

Getting back to the statement, the Fed was slightly stronger on inflation saying it will rise to 2%. This makes sense because prices have increased. I’d consider this to be another neutral statement. The final substantive change was removing the part about past energy price declines which makes sense because energy prices have been rebounding for many months.

FOMCChanges

The Fed is now more pessimistic about the economy than the private sector which is a role reversal from 6 months ago. January looks like it was a good month in terms of economic growth. Maybe the Fed doesn’t want to comment on this because it is snake bitten from the previous fits and starts of this weak recovery. My projection for zero rate hikes is outside the mainstream as the market only sees this as having a 5.8% chance of happening. When the Fed doesn’t raise rates in March, this percentage will likely increase. The market now foresees two rate hikes this year. There is a 71.3% chance of at least 2 rate hikes. If the Fed was serious about its plans for 3 rate hikes, it should’ve been more hawkish because, as of now, the market only gives a 37.4% chance that there will be 3 or more rate hikes.

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