FOMC raised the rate as highly expected

The FOMC raised the target range for the funds rate to 2-2.25% at its September meeting today. The widely expected rate hike is the eighth in the cycle that began in December 2015.

Powell reiterated the case for gradual rate hikes that he made in his Jackson Hole speech a month ago, presenting the Fed’s current path as balancing the risk of ending the recovery unnecessarily with the risk of overheating. For now, the Committee appears to see both risks as modest. The median 2018 GDP growth forecast rose to 3.1% and Powell saw little negative trade war impact on the overall economy, suggesting little risk of overdoing it for now. At the same time, Powell noted that the inflation process is “in a good place now,” suggesting that the Committee also sees little risk that it is moving too slowly.

Markets focused on the removal of the description of the policy stance as “accommodative” from the FOMC statement, but Powell noted that the change “does not signal any change in the likely path of policy.” He pointed out that all participants who submit longer-run dots do still view policy as accommodative, and explained that “accommodative” was instead removed because its original purpose—clarifying to markets after lift-off that the Fed still intended to support strong growth—no longer applied. Powell also noted that the removal did not indicate broader disenchantment with providing projections and defended the dot plot as providing useful information to financial markets.

The FOMC also took further small steps toward clarifying its plan to eventually manage the labor market overshoot. The median participant continued to project an eventual 1pp overshoot of NAIRU to 3.5% (vs. 3% GS), but the new 2021 projections show the unemployment rate rising 0.2pp that year, slowly creeping back to a sustainable level. Somewhat incongruously, the new projections show GDP growth still at potential in 2021 at 1.8%.

The expected increase in the unemployment rate in 2021 reflects the modestly restrictive projected policy stance at work. The median projection of the policy rate was flat at a terminal rate of 3.25-3.5% in the new 2021 dots. Roughly two participants appeared to expect an additional hike in 2021 and roughly six appeared to expect a cut, seemingly viewing a slightly less restrictive stance as appropriate at that point .

The projected move into restrictive territory was a frequent theme of Powell’s press conference. Powell cautioned that “forecasts two or three years out are fairly uncertain,” but added twice that reaching a restrictive stance is “very possible.” We saw three points as meaningful. First, Powell said that while the neutral rate moves very gradually, the FOMC might have underestimated it and could raise its estimate. Second, he said that where policy stands relative to neutral “isn’t really the question we’re answering;” instead, the FOMC will pragmatically set policy to sustain the recovery. Third, he described a restrictive stance as quite mundane, noting that it “happens often” and that the FOMC’s projected overshoot this time is “really modest.” These comments reinforce our view that neutral is not a barrier.

The press conference also offered some indication of what it would take for the Fed to deviate from its projected policy path. Powell said that potential triggers for a pause include either a “significant and lasting correction in financial markets or a slowing down in the economy that’s inconsistent with our forecast,” while the main trigger for raising rates more quickly would be an upside surprise to inflation.

We continue to expect 4 rate hikes in total in 2018 and 4 more in 2019 for a terminal rate of 3.25-3.5%, but see the risks as skewed to the upside. Upside risk could take the form of a faster pace of hikes if inflation surprises to the upside, a possibility we think is more likely than Fed officials appear to.

Upside risk could also take the form of a longer hiking cycle, especially if growth and the labor market remain stronger than we expect after 2019. While our forecast projects somewhat below-potential growth in 2020-2021, the FOMC’s forecasts have growth still above potential in 2020 and at potential in 2021. In such a scenario, we think some additional tightening would likely be required to achieve the FOMC’s goal of returning the labor market to a sustainable place.