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5-year Auction in 40 Mins Follows Weak 2-year Turnout

--FOMC Expected to Raise FFR Target Range to 1.25% to 1.50%
--2018 Rates Forecast Could Be Revised to 4 Hikes If 3 Dots Move Above 2.25%
By Jean Yung
     WASHINGTON (MNI) - With an interest rate increase all but locked in next
week, investors are shifting their attention to how Federal Reserve officials
will judge the implication of tax cuts on inflation and growth over the next few
years -- beginning with whether policymakers will nudge the number of
anticipated 2018 hikes to four. 
     Congress is working quickly to resolve the differences between the Senate
and House tax proposals with the goal of sending a final version to President
Donald Trump to sign by Christmas. The bills are broadly similar: Both would
lower the corporate tax rate and cut taxes for a majority of individuals. Both
cost some $1.5 trillion over 10 years -- with the expectation that the cuts
would pay for themselves by spurring growth and boosting taxable incomes.
     Question is, will tax reform prompt the Fed to tighten more aggressively
next year in view of a revised outlook for growth? 
     It would take just three Fed officials to move their projection for rates
by the end of next year above 2.25% to shift the median to four hikes rather
than three in 2018. In September, six officials forecast rates in a 2.00% to
2.25% range by year-end 2018 while rest were evenly split between the
two-or-fewer and four-or-more camps. 
     Since September, economic data has come in largely as expected, and the
initial impact from hurricane-related disruptions has largely faded. The
unemployment rate fell to 4.1% and third quarter GDP growth came in at a
better-than-expected 3.3%. Inflation remained below target but core PCE inched
higher. 
     --PERSONNEL CHANGES LOOMING
     A number of personnel changes are underway at the central bank. Both Chair
Janet Yellen and New York Fed chief Bill Dudley will step down next year while
the Senate will consider current Gov. Jay Powell to succeed Yellen and economist
Marvin Goodfriend to be a governor. Trump nominee Randal Quarles was sworn in as
Stanley Fischer departed the Board in October, a move that could amount to one
hawkish shift in forecasts though Quarles has yet to air his monetary policy
views and little is known about them. 
     --DISAGREEMENT ON THE IMPACT OF TAX CUTS
     Only a few Federal Open Market Committee members said they factored
legislative changes in their outlook as of the November meeting. That could
change in coming weeks as officials assess the economic impacts of the
legislation. 
     Yet the precise shape of tax reform remains unclear. President Trump put
one key detail -- the corporate rate -- in doubt over the weekend, when he said
the rate "could be 22 (percent)" in the final legislation. Some members may
prefer to wait until the new year to tweak their public views.
     Yellen has challenged some of the ideas underpinning the Republican tax
plan, particularly that corporate tax cuts will drive higher investment and
wages. 
     Those impacts are "very hard to detect in economic data," she told Congress
on Nov. 29. "We are suffering from slow productivity growth. In making fiscal
policy and other decisions the focus should be on how that can be improved."
     Without a boost to productivity or labor force participation, a fiscal
stimulus will have modest effects on economic growth over the long run, San
Francisco Fed Chief John Williams, who votes on rates next year, told MNI last
month. 
     At the time of his interview, which took place before either the House or
Senate passed their final bills, Williams said he's "not losing sleep" over
whether tax cuts or infrastructure funding bills are passed. Three hikes next
year will put the Fed in position to respond to a range of contingencies, from a
major fiscal stimulus to stubbornly low inflation or any other number of
economic curveballs, he said. 
     --MOST READY TO LIFT RATES FURTHER, OTHERS LESS SURE
     With unemployment at a 17-year low, most estimates suggest the economy is
already operating at a rate slightly above its long-term trend. That broad-based
momentum will drive the Fed's outlook and its march toward gradually higher
rates, even if inflation is lower than officials would like to see. 
     Most Fed officials, including Powell, are ready to lift rates. They are
confident that inflation will rise as the economy continues to grow and the
labor market approaches full employment. Importantly, closer-to-neutral rates
give them more scope to offer monetary stimulus to counter the next downturn. 
     The minority dovish faction of officials who want to wait to raise rates
until they see evidence that inflation is steadily rising could produce a
dissent or two. Possible candidates are Minneapolis Fed Bank President Neel
Kashkari and Chicago Fed President Charles Evans.
     A hawkish shift in the Summary of Economic Projections could bring markets
closer to the Fed's forecast path. Currently, futures traders are pricing in two
hikes next year. 
--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com
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