MNI PRE-FOMC: Fed Nears Neutral Zone with Next Hikes

--Investor Speculation Of Move From "Accommodative"

By Jean Yung

     WASHINGTON (MNI) - With the Federal Reserve all but certain to raise rates

this month, attention shifts to any indications the Fed is moving toward neutral

or even restrictive policy.

     The projected rate hike, coming on the heels of strong price and job market

data, would take the U.S. policy rate close to the range of Fed estimates of its

neutral setting for the first time since the financial crisis 10 years ago.

     With expectations of another rate increase in December also running high,

many investors wonder if the Fed will move away from describing current monetary

policy as "accommodative" in its post-meeting statement.

     Meanwhile, the Federal Open Markets Committee will provide updates to its

economic projections reflecting any impact from ongoing trade disputes as well

as the fading fiscal stimulus next year. 

     The FOMC will for the first time issue a point forecast for year-end 2021,

which could offer additional clues to the committee's views on the emerging

debate over where they see a break in the current tightening cycle.  

     --STEADY AS SHE GOES

     A hot labor market and inflation around target should prompt the Fed to

raise its benchmark rate another quarter point to a target range of 2% to 2.25%

Wednesday and once more in December, barring any downside surprises. 

     From there, officials have signaled they plan to continue nudging rates

higher to keep the economy on an even keel, but opinions differ as to how far

they need to go.

     Futures traders are currently pricing in two hikes in 2019, one fewer than

the FOMC's June forecast, and none in 2020 when the FOMC sees one. But as long

as inflation is stable and unemployment low, the Fed is likely to reiterate the

need to raise rates regularly.

     One key question in deciding the pace of hikes is whether inflation will

stabilize around the current 2% level or continue to accelerate on the back of a

tight labor market and a booming economy. New trade restrictions could also

pressure prices higher. Policymakers have pledged to act decisively should there

be signs of a sudden uptick in inflationary pressures but say they currently see

little risk of that.

     On the other hand, broader tariffs and a stronger dollar pose a downside

risk to the economy, though likely not enough to shift growth, unemployment and

inflation projections significantly as yet. Officials are still in wait-and-see

mode on whether trade tensions erupt into trade wars. 

     --WHERE IS NEUTRAL?

     Amid the discussion over the considerable uncertainty in estimates of the

neutral rate, Fed Governor Lael Brainard this month highlighted another

dimension to the unobservable rate's relevance for determining rates in the

immediate future. 

     The fiscal stimulus and rising asset prices are driving the short-run

neutral rate higher than their much-discussed longer run estimate, a scenario

which could justify raising interest rates beyond that level in the near term,

she argued.

     "This year, the unemployment rate has fallen further, and job market gains

have gathered strength, at the same time that the federal funds rate has

increased. This combination suggests that the short-run neutral interest rate

likely has also increased," she said. 

     The fiscal stimulus is likely to continue to bolster the short-run neutral

rate over the next two years, "and it may well surpass the longer-run

equilibrium rate for some period." 

     --RESTRICTIVE POLICY

     Other Fed officials including Chicago Fed President Charles Evans and

Boston Fed chief Eric Rosengren have been bolder.

     Evans this month noted that "the 3% to 3.5% level of the funds rate

projected for 2019 and 2020 is mildly restrictive." With "an unemployment rate

forecast below the natural rate, such a policy stance would be quite normal and

consistent with some moderation in growth and a gradual return of employment to

its longer-run sustainable level," he added. 

     While the debate over whether to pause at neutral or take the policy rate

steadily higher may simmer for some time, the Fed may sooner update how policy

is characterized in their statement. 

     Analysts have asked if the Fed will drop or modify the word "accommodative"

in describing the stance of monetary policy. Such a move might suggest greater

openness to taking rates to into restrictive territory. 

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

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

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