Fed Enters Brave New Forecasting World Beset With Same Old Data
(Bloomberg) -- Federal Reserve officials will face an unusual predicament as they update their economic projections this week: Everything has changed but the data.
In many ways, it feels like a brave new world. Chairman Jerome Powell makes his debut with an expected interest-rate increase, replacing Janet Yellen. Financial conditions have tightened and the five rate increases under Yellen since December 2015 are finally being felt in the real economy, at least in mortgage rates. Tax reform has passed and Congress is lifting government spending caps, boosting the near-term growth outlook.
Yet Fed officials swear by their data dependence, and the numbers look strikingly similar to when the policy-setting committee last met. The inflation pickup officials have been waiting for still hasn’t materialized, wages are ticking higher but hardly surging, economic growth is chugging along and the job market continues to pull people off the sidelines.
These five charts lay out the conditions the central bank faces as it lays out its new road map and its policy outlook this year.
Above, you can see the Fed’s economic projections for 2018 compared with where the economy stood when they made them in December. These estimates come out quarterly, meaning updated figures along with the rate decision statement will be issued on Wednesday.
While these key economic data points look broadly unchanged, important details hide behind the headline numbers.
The biggest evolution since December relates to overall growth. Fiscal stimulus from tax cuts and the budget deal should be a propellant for the economy this year.
President Donald Trump signed the tax plan into law on Dec. 22, nine days after the Fed’s last rate hike. Minutes from the Jan. 30-31 meeting of the Federal Open Market Committee -- a gathering that didn’t include new economic projections -- showed “a number” of policy makers had already upgraded their outlooks for 2018, citing an impact from tax changes “somewhat larger in the near term than previously thought.” The Fed’s GDP projection for the year seems to be headed for an upward revision.
Here’s a place where “no change” is actually a huge deal: Job gains continue at a pace well above what officials think is sustainable in the long run (for more on that, see this speech from San Francisco Fed Bank President John Williams), and labor force participation, which should be falling because of demographics, has stabilized.
The impact on economic projections is ambiguous. If more people are jumping into the job market and not immediately finding work, it could actually keep the jobless rate from falling further in the short run, as we’ve seen in recent months. On the other hand, modest wage pressures despite an extended period of low unemployment could persuade the Fed to lower its estimate of the sustainable jobless rate. Given those competing forces, the outlook could remain unchanged.
But make no mistake, this is a big deal. It’s causing some Fed officials, like the Minneapolis Fed’s Neel Kashkari, to wonder whether the economy is actually at full employment. That’s crucially important, because if it isn’t, policy makers could keep interest rates low without risking a takeoff in wages and inflation.
Speaking of prices, they’re crawling back up after a weak performance through the middle of 2017, but both the core Consumer Price Index and the Fed’s preferred gauge based on consumer spending habits remain below the central bank’s 2 percent goal.
Economists say that could change as the drag on the year-over-year figures from a mobile phone plan repricing falls out of the data later this spring. That’s been in train, so the Fed will have factored it in already. This one probably doesn’t need much of a mark-to-market.
Now we come to a particularly important projection on interest rates. Markets will also be hyper-focused on this year’s rate forecast, which could move higher.
The 2018 “dot” currently sits at 2.125 percent -- signaling three rate increases from the current 1.25-1.5 percent range, and four officials had higher projections at the December meeting. If Yellen was one of those high dots, at least five officials must adjust their expectations higher to move the median higher. If she was at or below the median, four must.
What’s equally interesting, even if less-appreciated, is the long-run interest-rate projection. The median Fed official pegged it at 2.8 percent in December, suggesting the so-called neutral rate that neither stokes nor slows growth will be much lower in the future than it has been in the past.
If two or three members around the Fed table think that recent tax cuts and deregulation could boost the supply-side of the economy and stoke investment and productivity, it could push the long-run dot higher. That would send a signal that the central bank sees a reinvigorated American economy with room to run.
“If the Fed is hiking alongside a rising longer-run rate estimate it suggests that they are not tightening policy all that much,” Neil Dutta, head of U.S. economics at Renaissance Macro Research, wrote in a pre-meeting analysis.
©2018 Bloomberg L.P.