The Federal Reserve has maintained its Fed Funds rate at 0% (the so-called Zero Interest Rate Policy or ZIRP) for fully six-and-a-half years in an effort to stimulate the economy and bring down the unemployment rate. The Fed Funds rate will be at the same level come this time tomorrow, despite encouraging signs of a “spring thaw” in economic activity.
Now that we have that inevitability out of the way, let’s get into what actually could change. In our view, there are three major areas of focus for tomorrow’s Fed bonanza:
1) Economic Projections and the “Dot Chart”
This month’s meeting marks one of the quarterly meetings where the central bank will update its Summary of Economic Projections, with specific year-end forecasts for economic growth, unemployment, inflation, and of course, the so-called “dot chart” of interest rate expectations. After the slow start to the year, FOMC members are likely to revise down their expectations for economic growth for 2015 (potentially revising up 2016’s anticipated growth to compensate). On the other hand, the continued recovery in the labor market should keep the expected year-end unemployment rate steady near 5.0%.
The two most important aspects of the Summary of Economic Projections will be the anticipated inflation rate and the expe3cted number of interest rate hikes this year. In March, the committee expected Core PCE inflation to come in at 1.3-1.4% at the end of the year, but policymakers could revise that figure higher in the wake of the strong average hourly earnings and other inflation data. Meanwhile, the dollar’s immediate reaction to the release may hinge on the median year-end interest rate expectations; in other words, how many interest rate hikes do Fed members anticipate this year? The mean expectation was for rates to finish the year at 0.675%, meaning that FOMC members anticipated two rate increases this year, but after the Q1 slowdown, some members may have pushed back their timeframe for “liftoff.” If the median year-end interest rate expectation falls to just 0.375%, representing just a single rate increase the year, the dollar could suffer.
2) The Votes
While we think there’s essentially no chance that the central bank as a whole will opt to raise interest rates, one or more of the more hawkish members may express their concerns by dissenting against the group. A certain level of disagreement is unavoidable whenever you get nearly twenty economists together in a room, but Fed Chair Janet Yellen has managed to craft a culture of consensus over her short tenure; there has not been a single dissent under her watch over the first three meetings of the year, and the only dissents last year were departing members who wanted to make a statement before rotating out of their voting roles (Fisher, Kocherlakota, and Plosser).
The previous trend of conciliation within the FOMC could come to an end this month, with one of the hawkish-leaning voters (Jeffery Lacker comes to mind) potentially voting in favor of an immediate rate hike. Needless to say, any support for an immediate rate hike would lower the hurdle for a hike later on this year and should support the dollar.
3) Janet Yellen’s Speech
Ever the savvy central banker, Janet Yellen will almost certainly leave the timing of the Fed’s first rate hike an open question (likely repeatedly reiterating the central bank is “data dependent” along the way), but the “spin” she puts on the statement will impact how traders interpret the release. If she downplays the expected negative revision to GDP growth and implies the economic recovery is finally accelerating, the dollar could benefit. Alternatively, if she refuses to say anything overtly positive about the economy, expectant dollar bulls will likely be disappointed and the greenback could pullback as a result. Readers should also keep an eye out for mentions of any other wild cards, including any concerns about Greece, China, falling bond prices or the relatively elevated value of the dollar.
As a final note, traders remain highly skeptical of a September rate hike. To wit, Fed Funds futures traders are currently pricing in just a 25% chance of rates rising in September, compared to the financial media, which anecdotally views September as the absolute latest that the central bank will move. Therefore, if it appears that a September rate increase is the Fed’s base case after tomorrow’s fireworks, traders may pile into the US dollar and the Treasury bond market to catch up.