MNI PRE-FOMC: 2019 Outlook May Mark Inflection Point for Hikes

By Jean Yung

     WASHINGTON (MNI) - The Federal Reserve is set to raise interest rates

Wednesday on the back of generally strong economic data, despite equity market

turbulence and U.S.-China trade tensions which have sparked investor doubts

about the scope for further rate hikes.

     The Federal Open Market Committee will likely maintain a tightening bias.

But changes to next week's policy statement and economic projections will

underscore the crucial shift in the Fed's attitude toward future rate hikes in

recent weeks.

     As MNI reported last month, the FOMC could be a lot closer to the peak in

this hiking cycle than many investors believed following Chair Jay Powell's

remark in October that rates were a "long way" from neutral -- the level beyond

which they would cool a strong economy. The Fed chief later revised his

assessment, saying rates were "just below" neutral.

     The change may be made evident in a downshift in rate projections for 2019,

to two hikes from the September's three, as many analysts expect, and a shift in

language toward flexibility and data dependence over the steady-but-gradual

mantra of recent years.

     --HIKES STILL ON TABLE

     2018 has been volatile for stock-market returns, with the S&P 500 now 10%

below the year's high. But, despite repeated attacks from President Donald

Trump, who blamed rate hikes for Wall Street sell-offs, real economic activity

would have to be credibly threatened for the Fed to alter course, and market

gyrations alone are insufficient.

     So far there has been no hint of significant shifts in the outlooks for GDP

growth, the labor market or inflation.

     Despite a slightly disappointing November jobs report and moderating trend

inflation this quarter, data are still roughly in line with expectations. That

should warrant a base case including some further tightening, even as the Fed

begins to prepare a new policy approach.

     --DATA DEPENDENT

     November FOMC minutes hinted its policy statement would soon drop explicit

forward guidance on "further gradual increases" in favor of a more flexible

attitude predicated on feedback from incoming inflation, employment and growth

data.

     With rates rising into a target range of 2.25% to 2.5% after December,

policy will be just below the committee's estimates of neutral, which range from

2.5% to 3.5%.

     Powell has emphasized estimates of neutral are highly uncertain, promising

that the Fed would proceed cautiously as officials "slow down," "stop," and

"feel [their] way" through a dark room. New language capturing the more flexible

stance would help guide investors to expect increased uncertainty.

     --2019 DOTS

     Depending on where newly-appointed Governor Miki Bowman positions herself,

either one or two policymakers would need to lower their outlook to move the

median rate projection for 2019.

     If the Fed stands by its three-hike forecast for 2019, Powell can project

an image of independence and resolve with data to back him up. If instead the

Fed flattens its baseline, he can offer reassurance for markets while signaling

the FOMC has not underestimated downside risks.

     Next year, the fiscal stimulus will start wearing off just as the economy

is still digesting earlier Fed rate hikes. A global growth slowdown, trade

uncertainty and geopolitical risks also weigh.

     The November minutes indicated the Fed views decelerating housing as more

on schedule than a concern. They may even want higher rates in this sector of

the economy, if it facilitates a smooth path for inflation.

     But the best time to execute continued rate increases is far from clear.

And with Powell's move to eight press conferences next year, he has created more

options to pull the trigger when the time is right.

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

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