While BofAML's Michael Hanson expects Yellen’s overall tone to remain dovish, market perception will be key. The combination of changes to the forward guidance language, upward drift of the dots, and any comments seen as potentially hawkish, could lead to a selloff...
Risk of a hawkish read
The September FOMC meeting may be the most anticipated in nearly a year. We expect no fundamental changes in Fed policy, despite revising the statement to clarify policy data dependence and some upward drift in the dots. The FOMC should taper by another $10bn as well. Fed Chair Janet Yellen’s press conference will set the tone for the market reaction. While we anticipate she will continue to support a patient and gradual normalization process, the risk is that markets may sell off on the perception of a less dovish Fed.
The FOMC statement has been the focus of much market speculation recently. The “significant underutilization of labor resources” phrase should be retained, in our view, given the soft August jobs report and only slight improvement on net since the July meeting. Conversely the “considerable time” language is likely to revised, in our view, as several Fed officials worry it sounds too much like calendar guidance. To reinforce the data dependent nature of policy, the FOMC could suggest that they will maintain the current 0 to ¼ percent funds rate target range until there has been “considerable progress toward the dual mandate objectives.” We also expect the statement to note that these changes do not reflect a shift in policy preferences, and for Yellen to reiterate that point at the press conference. Still, the risk is that markets see these revisions as a hawkish move in the timing of liftoff.
The Summary of Economic Projections (SEP) should reveal a slight revision lower for the unemployment rate forecasts for this year and next. We expect a modest upward drift to the 2015 and 2016 dots as well, as some centrist Fed officials have recently shifted to “midyear” from “second half” for their expected start to the tightening cycle. (We just updated our own forecast for the Fed’s first rate hike to June 2015 from September.) The 2017 forecasts will be included for the first time; we look for the median dot to be between 3.25 and 3.50%, with the median ex-hawks at that lower bound. The median longer-run policy rate projection should remain at 3.75%.
Recall that Governor Lael Brainard participates in the SEP for the first time at this meeting.
Market risk also drifts up
Markets are priced well below just about any reasonable variation on the median dot, and a recent San Francisco Fed paper noted that the market seems both too dovish and too certain about Fed policy as well.
Drifting dots thus represent a significant risk for a selloff in the markets. While we expect Yellen to de-emphasize the dots at the press conference - they are not a consensus policy tool, after all - markets may have difficulty looking past them this time.
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Meet the press
Finally, Chair Yellen will likely continue her more balanced discussion of the labor market outlook, yet still emphasize a patient approach to policy normalization. She also may update the discussion around the revised Exit Strategy Principles, but a formal restatement may not appear until later this year. While we expect Yellen’s overall tone to remain dovish, market perception will be key. The combination of changes to the forward guidance language, upward drift of the dots, and any comments seen as potentially hawkish, could lead to a selloff, particularly at the short end of the yield curve.