MNI PRE-FOMC: Most Indicators Flash Green As Yellen Exits

--Fed Expected to Hold Rates Steady in Jan Meet, Little Change in Statement

--On Track for Quarterly Hikes, Three or More if Economy Surprises to Upside

By Jean Yung

     WASHINGTON (MNI) - With the U.S. economy surging and cyclical inflationary

factors set to exert themselves, expect the Fed to stick to its game plan on

interest rates: three hikes this year, or more if the economy performs better

than expected. 

     The Federal Reserve remains on track for continued monetary tightening in

2018 as Chair Janet Yellen prepare for her final policy meeting Jan. 30-31.

While officials have laid out a path of rate hikes at the three-a-year pace to

which markets have become newly accustomed, better-than-expected economic data

could push them toward four or even more.

     After Yellen called low inflation the "biggest surprise" in the economy

last year, there are signs it has turned a corner. Fed officials have been

signaling their willingness to accept above-target inflation for a period of

time -- even welcoming it. The core personal consumption expenditures price

index, the inflation gauge favored by policymakers, accelerated to 1.5% in

November from a low of 1.3% in August.

     While structural factors such as technology-related disruptions and

globalization could cap price pressures, cyclical factors driving inflation

could take over this year. One-off price adjustments for cheaper mobile service

plans and a slowdown in key categories like health care will also drop out of

the year-on-year calculations by spring. 

--ROBUST GROWTH 

     Meanwhile, the economy is moving full steam ahead. Both U.S. and global

growth continues to run well above trend, with momentum sustained across both

developed and emerging markets. U.S. GDP looks poised for 2.75% to 3.75% growth

over the next couple of quarters on the back of an overhaul of the U.S. tax

system recently signed by President Donald Trump. 

     Stock markets are fully risk-on and sentiment toward investment spending is

changing as firms loosen purse strings to lay out for new capital. 

     The Federal Open Market Committee in December reckoned it had already met

one half of its dual mandate -- maximum employment -- while the first jobs

report of the year showed steady improvement in the labor market without signs

of overheating wage growth. That makes an argument neither for slowing nor

quickening the pace of tightening. 

--MARKET DIGESTION 

     With most indicators flashing green, it is reasonable for the Fed to push a

balanced outlook while continuing to tighten at the pace the market is already

comfortable with, which is to say one hike per quarter. That could mean three or

even four hikes in 2018, as there will be no balance sheet reduction

announcement as a substitute for a rate increase this year.

     Expect little if any edits in the January policy statement, save for an

update of the Fed's assessment of current economic conditions, which could hint

at progress toward its inflation target. 

     Although the bar is likely to be set high for a rates path significantly

more aggressive than the median forecast for the year, the FOMC has hinted it

might consider that option under the right circumstances. "Participants

discussed several risks that, if realized, could necessitate a steeper path of

increases in the target range; these risks included the possibility that

inflation pressures could build unduly...perhaps owing to fiscal stimulus or

accommodative financial-market conditions," according to the minutes of the

December meeting. 

     At the same time, a hike at an off-quarterly meeting would invite some

confusion and possibly market indigestion. And if the economic outlook or

markets were to falter, the Fed could quickly halt intentions for a quarterly

hike

--YIELD CURVE WORRIES

     One counter indicator has been the yield curve. Fed-linked short-term rates

such as 2-year Treasury notes are high compared to subdued long-term yields.

That could reflect the fact that the Treasury is finding it easy to place

long-dated debt with investors, or that markets expect the current robust pace

of growth to unwind in the next 12 months, or both. 

     As the FOMC cautioned in the December minutes, the flatter yield curve at

present isn't unusual by historical standards and should not immediately be

interpreted as a warning signal. But policymakers are also keen not to

contribute toward a curve inversion, a bad omen for the economy. 

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

[TOPICS: MMUFE$,M$U$$$,MT$$$$,MX$$$$]