MNI PRE-FOMC: Weight Shifts Toward Growth, Price Pressure

--Expect Economic Forecasts to Drift Higher But 4 Dots in 2018 Iffy

--25bp Hike Expected to Put FFR in 1.50%-1.75% Range

--Too Soon to Dispense With 'Gradual' Pace of Increases 

By Jean Yung

     WASHINGTON (MNI) - A quarter-point interest rate hike to finish Jay

Powell's first Federal Open Market Committee meeting as chairman Wednesday --

taking the target range for the fed funds rate to 1.50% to 1.75% -- is widely

considered a foregone conclusion. But what the FOMC will reveal about its

improving forecast for the U.S. economy could shed light on the prospect for

four or even five rate hikes this year. 

     Strong labor market conditions, a rebound in inflation and the passage of

substantial fiscal stimulus set to boost U.S. growth have raised the likelihood

the FOMC might accelerate its projected pace of tightening. But it may be too

soon for the Fed to signal its changing views by penciling in a fourth hike for

2018. Instead, the Fed could rely more heavily on upgraded economic projections

and just small tweaks to its policy statement to hint at higher rates down the

road. 

     Powell has indicated that the Federal Reserve needs to strike a balance

between avoiding overheating and bringing inflation to target as economic

headwinds turn into tailwinds. Yet with no immediate signs of overheating, the

core of the committee can afford to wait until economic data make clear the need

to lift its projected path, especially if inflation consistently overshoots

expectations. 

     --STRENGTHENING OUTLOOK

     "My personal outlook for the economy has strengthened since December," the

new Fed chair told Congress last month, foreshadowing upgrades to projections

for GDP growth in the wake of tax cuts and a larger-than-expected boost to

government spending over the next two years. Governor Lael Brainard recently

estimated the effect to be a half a percentage point boost in GDP growth for

both 2018 and 2019. 

     Faster growth would go hand-in-hand with a lower unemployment rate, which

officials in December saw falling to 3.9% by year-end. Job gains have already

picked up: Average monthly payroll gains over the past three months have risen

to 242,000, compared to 190,000 over the past year, though the unemployment rate

stayed at 4.1% for a fifth straight month in February. 

     But other hard data have argued for caution. Two straight sets of weak

retail sales data, real consumer spending declining in January and mixed signals

on wage growth lower the urgency for the FOMC to send a clear hawkish signal. 

     --WATCHING INFLATION 

     Powell again pledged last month to "monitor inflation developments closely"

in light of the continued shortfall from the 2% objective. Core PCE inflation

stood at just 1.5% in January, down from a high of 1.9% last year. 

     The FOMC likely wants to see more evidence that inflation will hold steady

at or above the 2% target before signaling that it is no longer concerned about

downside risks, for example by altering its assessment that near-term risks to

the outlook are "roughly balanced" or by upgrading its inflation projections. 

     The good news is there are signs of rising price pressures. The three-month

annualized core CPI inflation rate rose to a decade high of 3.1% in February, a

fact the FOMC may choose to highlight in its review of the economic situation.

This month, the base effects of the sharp drop in wireless telephone services

prices will fall out of the calculation, which should buoy year-on-year CPI

going forward. 

     New York Fed President Bill Dudley said in January he would tolerate a

small and temporary overshoot of 2% as demonstrating that the FOMC's target is

symmetric. Four hikes this year would still constitute a "gradual" pace, he said

last month. 

     --DOTS IN PLAY

     The dots this week could drift upward, but the median hikes this year may

be left at three for now. The median path in 2019 may be due for an nudge up to

three from the two projected in December. Short-term interest rate futures are

currently showing less than 40 basis points of tightening next year. 

     It is also possible the longer-run neutral rate could rebound, if

policymakers judge the fiscal stimulus as lifting the economy's long-term growth

potential. New York Fed Vice President Marco Del Negro told MNI last month that

there appears to be evidence key trends influencing the natural rate are

changing both over the short run and farther out.

     The committee could add a modifier to the "gradual" pace of increases in

its forward guidance. One possibility is to characterize the pace as "regular

but gradual," a phrasing Boston Fed President Eric Rosengren debuted in his last

remarks. Some investors have wondered if the Fed will increase the frequency of

press conferences, currently held quarterly, to prepare the way for a faster

pace of tightening down the road.

     In short, expect the Fed to signal flexibility, putting the dots in play

but leaving decisive changes for later in the year. 

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

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