Federal Reserve (Fed) Chair Jay Powell will preside over his first Fed policy meeting March 20–21. Although this is his first meeting as chair, Powell has been a voting member of the policy committee since 2012 and is a seasoned veteran of Fed policy meetings. The Fed is widely expected to raise the target range for the fed funds rate 0.25 percentage points, from 1.25–1.50% to 1.50–1.75%, and anything more (or less) would be a shock for markets. With a rate hike already priced in, markets will be scrutinizing the Fed’s policy statement, Powell’s press conference following the meeting, and updated economic projections (last released in December 2017) for any hint of changes in the future path of Fed policy.
The Dot Plot Thickens
The Fed has been signaling, and markets continue to expect, a steady but gradual rise in the Fed’s policy rate. In order to help gauge any change in the Fed’s expectations, markets monitor interest rate projections via the “dot plots.” These estimates, provided by each member of the Fed’s Board of Governors and the regional Fed bank presidents, capture the projected level of rates at the end of 2018, 2019, 2020, and in the “longer run,” with each view represented by an unlabeled dot. With 12 regional bank presidents and 7 Fed board positions, the maximum number of dots is 19. However, there are four empty board seats following former Chair Janet Yellen’s departure, reducing the number of dots in the upcoming projections to 15.
At Wednesday’s meeting, with only 15 projections, the eighth dot will be the magical middle, or median, dot. The December 2017 projections had six dots indicating an expectation of fewer than three hikes in 2018, six dots at three rate hikes, and four dots at more than three hikes, putting the median at three hikes. We expect the central tendency of the dots to thicken this time, with dots in the lower range moving toward the middle. With the eighth dot being the median, we would need to see four projections move from an expectation of three rate hikes to four to see the median move. Since the idea of four hikes was only floated by Powell as a possibility in his recent congressional testimony, we believe such a large shift is plausible but unlikely. However, it could become more likely with a significantly more upbeat assessment of the economy.
First Look At The Impact of Fiscal Stimulus
While the Fed will be focused on inflation, inflation expectations are heavily influenced by changes in expected economic growth. The Fed’s last set of economic projections was released on December 13, 2017, before the Tax Cuts and Jobs Act passed. Since then we have also seen the Republican-led Congress raise spending limits by $300 billion over the next two years. While fiscal stimulus can provide long-term benefits if it spurs investment, and we believe significant pieces of the tax legislation point in this direction, such a large package of deficit-financed stimulus is unusual at this point in the economic cycle. In particular, the addition of higher spending caps increases the likelihood that recent stimulus may artificially raise growth above potential, pulling future growth forward and increasing upside inflationary risk.
The economic projections accompanying the upcoming meeting will be the first in which Fed members will have the opportunity to fully price in the recent stimulus measures. We did get some sense of Powell’s assessment during his congressional testimony in February. Powell’s favorable view of the economy led markets to slightly increase the possibility of a fourth rate hike, but the fed funds futures implied odds of a fourth hike have generally remained near a one-in-three chance. In December, the median projection for 2018 gross domestic product (GDP) had already increased to 2.5%, from 2.1% at the September meeting. Expect markets to take a modest further increase in stride. A shift in the median expected growth rate above the symbolic 3.0% level, however, may increase expectations of a more aggressive Fed.