The FOMC concludes two days of meetings today and that means the market will mark time until 2pm ET. While there’s no chance of a rate hike, the real drama will be in just how dovish the Fed is in its statement, forecasts and press conference. We expect that the balance sheet tapering will be discussed too with the shrinking of the Treasury portfolio possibly completed by year-end. We go into more detail below on our expectations but suffice it to say the dovish tone that has prevailed in 2019 will likely continue with today’s information. The bigger question may be whether the plethora of data will be consistent or will there be something amiss that muddies the message? In the meantime, the 10-year Treasury sits at 2.59% this morning, up 6/32nds in price. A markedly dovish tone that beats market expectations from today's proceedings—and that could be hard to do— would put the year-to-date low of 2.55% in play while a more neutral or balanced message could pressure yields back towards recent support at 2.65%.
|Economic News||Consumer Still Has Spending Firepower||Agency Indications|
The big event of the week arrives this afternoon with the FOMC rate decision. While there’s no chance of a rate hike the real drama lies in the updated rate and economic forecasts and how dovish they are. Recall in December the Fed expected two hikes in 2019 with another in 2020. Equity markets spent the rest of the month spiraling downward and the Fed quickly pivoted to a dovish posture in January. The question for today is not so much if the dovish tone persists but just how dovish it will be?
That being said, for all the dovish talk since the start of the year there are still some glass half-full elements to consider. One of those is that with annual wage gains moving higher and approaching 3.5% the consumer seems to have increasing firepower to resume solid spending in the spring and summer (see chart below). Those accelerating wage gains could also prompt a boost in productivity-enhancing business investment which has been few and far between so far in this economic expansion. Also, the recent dip in mortgage rates, moderating home price appreciation, and the aforementioned wage gains provide an affordability boost that could lead to a rebound in housing activity this year.
Thus, while the Fed has reason to pause in 2019, to take all possible hikes off the table this year and next year seems a bridge too far. We think they leave one hike —could be 2019 or 2020— in the forecast but that should be the last in this cycle. With some Fed speakers mentioning the current fed funds rate sitting at or near neutral, projecting anything more than a single hike into the forecast given the likely slowing trend in GDP and inflation would seem at odds with recent communication and forecasts.
There has been some market speculation that the longer-run “dot” at 2.75% —which represents participants’ median neutral level—could come in for a cut as well. And while there were seven of sixteen participants forecasting a 3% or better longer-run rate in December, getting the median to drop from 2.75% at today’s meeting will be a heavy lift mathematically-speaking. In essence, we would need to see four of the five “dots” currently at 2.75% move their forecast lower. That’s certainly possible but that seems a rather drastic move what with positives still present in the domestic economy and the ultimate uncertainty surrounding the true neutral rate level. Thus, we think it more likely we see the 3+% cohort coalesce around 2.75% from above rather than those at 2.75% drop their rate to 2.625% or 2.50%.
Moving on to the updated economic forecast, recall the December meeting called for 2019 GDP to be 2.3%. That’s likely to be cut closer to 2.0% given the expected 1% or less first quarter forecast and the continued signs of global weakness. A weaker growth forecast will align with the dovish pivot in January and justify cutting the three expected hikes in the December forecast to one or none.
Another forecast we expect to see cut is the longer-run, or equilibrium, unemployment rate. This is the Goldilocks rate that represents a labor market running not too hot nor too cold. For the last few forecasts it’s been stuck at 4.4% but with actual unemployment running well below that level and with wage inflation remaining tame—albeit with a little push higher of late— the 4.4% estimate understates the actual level of slack that has been in the labor market. If the Fed, as expected, cuts its rate hiking expectations it seems necessary they will need to cut their estimate of the equilibrium unemployment rate as well to something closer to 4.0%-4.25% to remain consistent with the current level of unemployment and the dovish rate posture.
In summary, we expect a dovish Fed today both in forecasts and in the press conference. The market—fixed income and equity—expects a dovish Fed, so the question is will the flood of new information from the statement to the forecasts to the press conference convey a sufficiently dovish message that allows Treasuries to retain recent gains, or will there be a more muddled message that causes yields to back-up? In any event, we will be back with a summary of the meeting this afternoon.
Consumer Still Has Spending Firepower
While the Fed is expected to convey a dovish tone today, there are signs that the economic expansion is not finished yet. With two-thirds of GDP comprised of consumer consumption, assessing the state of the consumer is key. In that regard, with the labor market continuing to impress, confidence readings rebounding after year-end market volatility, and wage gains accelerating, the consumer would seem to be in a good spot. Another indicator of this is in the graph. It’s a Fed-derived measure that shows financial obligations—debt and other typical monthly expenses— to disposable income is near multi-decade lows indicating the consumer still has plenty of capacity to spend when they so desire. That should keep the economy in good stead in the months ahead.
Agency Indications — FNMA / FHLMC Callable Rates