MNI POST-FOMC: Fed Readies to Pick Up Pace on Rates

--Hawkish Language in Jan Statement Sets Up 2018 Tightening

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve on Wednesday teed markets up for a

March interest rate increase and signaled it might have to pick up the pace of

rate hikes this year if the economy appeared to be en route to overheating. 

     As expected, the Federal Open Market Committee left the fed funds target

range unchanged at 1.25% and 1.50%, but it mildly surprised markets with a tweak

to its forward guidance, warning that "further" rate hikes might be warranted to

keep the economy expanding at a moderate pace and labor market conditions to

stay strong. 

     "The Committee expects that economic conditions will evolve in a manner

that will warrant further gradual increases in the federal funds rate; the

federal funds rate is likely to remain, for some time, below levels that are

expected to prevail in the longer run," the FOMC said. 

     With the fed funds futures market already pricing in a 0.69 percentage

point increase in the benchmark rate this year ahead of Wednesday's meeting,

very close to the FOMC's own projection, the insertion of the word would seem

unnecessary. Doing so hints at the FOMC's intention to add the option of

speeding up the pace of hikes this year as it keeps an eye on how the new tax

cuts will spur growth and inflation. 

     On the back of another solid quarter of GDP growth, the FOMC's assessment

of economic conditions was again optimistic. Consumption and investment growth

were "solid" in the past six weeks. 

     Meanwhile, the unemployment rate "has stayed low" and is expected to fall

further below its estimated natural rate this year. Analysts surveyed by MNI see

the jobless rate dipping another tenth to a fresh 17-year low of 4.0% in January

when the Labor Department releases its report Friday. Over the past year, it

fell 0.6 percentage point from 4.7% to 4.1%, already a very low rate by

historical standards. 

     The FOMC's near-term outlook on inflation seems to have also turned a

corner. The statement dropped the line about expecting inflation to "remain

somewhat below 2 percent in the near term," instead saying with added confidence

that inflation was expected "to move up this year." The FOMC also noted that

market-based measures of inflation compensation have "increased in recent

months". 

     Adding to that are loose financial conditions and depreciation in the

dollar that could further boost spending and feed through to higher inflation. 

     Another thorny question for the Fed is whether so-called r-star, or the

neutral policy rate, will rise over time. The FOMC currently estimates it to be

around 2.75%, only about five hikes away. Correspondingly, Fed officials expect

to raise rates just a tad over that terminal rate for this business cycle.

Markets currently see the terminal rate at about 2.5%.  

     A better outlook for productivity growth could raise the equilibrium rate.

However, Thursday's nonfarm productivity data pointed at an unexpected slowdown

in the fourth quarter. Productivity fell 0.1%, compared with a 0.7% gain

expected, though for the year as a whole, productivity was up 1.2% compared with

a 0.1% decline for all of 2016. The recent uptick in business fixed investment

could drive productivity higher, though, as the economists have pointed out,

jumps in productivity growth have not historically been forecastable. 

     The next CPI report will be released on Feb. 14, around the time that new

Chair Jay Powell will deliver his first semiannual monetary policy report to

Congress. 

     The release of the minutes of the January meeting on Feb. 21 could also

offer more insight into the January discussion. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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