MNI POST-FOMC: Signs of A Move Away From Phillips Curve

--Inflation, Rates Projections Left Largely Intact Despite Faster Growth

--Median FOMC Forecast Remains at 3 Hikes in 2018, 2 in 2019

--Nearly All Officials Factored Tax Cuts Into Forecasts

By Jean Yung

     WASHINGTON (MNI) - It would have only taken three of 16 Federal Reserve

officials to conclude that faster growth and lower unemployment implied higher

interest rates to lift the Fed's rates outlook for 2018, yet officials Wednesday

surprised some investors by leaving the median dots where they were next year

and in 2019, even as their outlook for growth and employment improved. 

     With nearly all members of the Federal Open Market Committee factoring into

their projections the prospect of a fiscal stimulus along the lines of what

Congress is contemplating, expected GDP growth rose to 2.5% next year,

four-tenths better than the FOMC's September forecast and seven-tenths above the

economy's longer run growth rate. 

     The jobless rate, already below the FOMC's estimate of full employment, is

now expected to sink further to 3.9% in 2018 and 2019. But inflation forecasts

remained unchanged, rising to the Fed's 2% target by 2019, same as in the

September set of forecasts. 

     With no output gap or employment gap, the median policymaker continued to

see three quarter-point interest rate increases next year followed by two in

2019, the same as in September.

     --BREAKING FROM PHILLIPS

     Fed officials appear to be signaling stronger confidence in the economy's

ability to grow without stoking inflation. That would go hand in hand with a

move away from the Phillips Curve framework -- that there is a relationship

between the degree of slack in the labor market and inflation. 

     Ahead of the FOMC decision, 10-year yields hit 2.43% on the prospect that

officials might signal an accelerated pace of tightening next year. Yields

backed off to 2.35% as Yellen concluded her final press conference, partly on

the Fed's less-than-hawkish sentiment regarding 2018. 

     Asked if there was some inherent discrepancy in the FOMC's newest

forecasts, Chair Janet Yellen cautioned that the forecasts are a composite of 16

varying viewpoints and should not be read as that of one individual but also

nodded to the fact that some officials are "rethinking" what's determining

inflation. 

     "You are looking at 16 participants who have made adjustments to their

economic outlook for a whole variety of reasons, including in some cases

rethinking some of the fundamentals that went into their original forecast," she

said. 

     "Growth is a little stronger, the unemployment rate runs a little bit

lower, that would perhaps push in the direction of slightly tighter monetary

policy," she continued. "But again, counterbalancing that is that inflation has

run lower than we expect, and it could take a longer period of a very strong

labor market in order to achieve the inflation objective." 

     One indication of a weaker Phillips Curve relationship is wage pressures,

which have remained "modest," the chair said. 

     "That's one factor -- along with the fact that inflation remains low --

that gives the feeling that even though we have a 4.1% unemployment rate, that

the labor market is not overheated at this point."

     --TAX CUT IMPACT

     Neither did policymakers raise their projection for potential growth of the

economy, implying they don't expect the tax package to significantly boost

productivity growth over the long run. 

     Yellen said the FOMC sees mainly a demand effect from the corporate tax

cuts, though higher business investment could in turn boost capital formation

and spur productivity growth. Still, she added, "there is a good deal of

uncertainty about what the impacts would be." 

     A larger than expected impact on potential GDP growth would be "welcome" in

an economy that's had "disturbingly low productivity growth," she said, and it

"could support faster GDP growth at least for some period without creating the

need to tighten monetary policy to offset that." 

     --INFLATION STILL A MYSTERY

     For now, Yellen reiterated that the FOMC still judges transitory factors

unrelated to the broader macroeconomic outlook as holding inflation down, but

she again brought up the uncertainty clouding the inflation conundrum. 

     "I have tried to be straightforward in saying that this could end up being

something that is more ingrained and turns out to be permanent," she said. "It's

very important to watch it. And if necessary, rethink what's determining

inflation." 

     One possibility, she added, is that estimates of the longer run sustainable

rate of unemployment "need to come down even more," or that inflation

expectations have slipped, though that is not her own judgment.  

     "I think it's important to watch inflation outcomes carefully. And, if we

don't see inflation moving in the manner that the committee anticipates, to

alter policy so that we do achieve our 2% objective," she said.  

     However, "At the moment, most of my colleagues and I believe we are on

track to achieve it." 

     That could change, and it would mean a more dovish arc for the Fed over the

long run than investors expect. 

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

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