FOMC preview: Dipping dots

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Although the Federal Reserve has made clear it will hold interest rates for the time being, the panel still has much to discuss, including the end of balance sheet normalization and the Fed's review of how it formulates, conducts, and communicates monetary policy.

A decision on an end to balance sheet run-off and a new Summary of Economic Projections, with lower projections for future interest rate increases, will be the highlights of the March 19-20 Federal Open Market Committee meeting.

"[W]ith zero probability of a rate change priced in, the most interesting aspect of the meeting will probably be the dots," said Arthur Bass, managing director of fixed income financing, futures and rates at Wedbush.

The previous SEP had a mean estimate of two tightenings this year, but markets now see "more than 25% probability of an ease by December," he said. "While the market underestimated the dots last year, as the Fed did tighten four times … it will be interesting if they still project one move."

Federal Reserve Board Chair Jerome Powell's March 10 appearance on 60 Minutes "was a planned message that the Fed is on hold until they see stronger economic signs," he said. "I believe they got scared by the decline in risk markets following their move in December."
The Fed will stay on hold through 2020, unless there's a big acceleration of growth, Andrew Schneider, US Senior Economist at BNP Paribas said at a Research & Strategy Global Outlook briefing. "We think a recession will be averted," although there's still a 25% chance.

The Fed is "probably done hiking" this cycle, Shahid Ladtha, BNP Paribas Head of Strategy for G10 Rates, Americas said at the same briefing. He expects the Fed will decide at this meeting when it will end balance sheet roll-off.

The Fed still needs to decide the size and composition of its balance sheet after quantitative tightening ends, and the risk of ending normalization earlier than thought, Ladtha said.

"We expect the FOMC to announce that the balance sheet run-off will conclude at year-end and the median dot to point to one hike each in 2019 and 2020," said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.

In addition to the dots being lowered, the Fed is likely to cut growth projections this year. Morgan Stanley's research team said it expects the FOMC to "take down its median forecast for growth this year, raise it in 2020, and allow for an inflation overshoot in the out years."

It expects "a substantial move lower in the dots that brings the median down to one hike in 2019," and rates not moving into restrictive territory. "Our strategists believe a more dovish dot plot will send Treasury yields lower, both outright and cross-market."

Morgan Stanley expects the Fed to officially announce the framework for the end of balance sheet reduction, with run-offs stopping in September. It targets December and June 2020 for rate increases.

The February employment report's "headline miss" on job creation overshadowed the report's "faster wage growth," said Stifel Nicolaus & Co. Chief Economist Lindsey M. Piegza in a note. "After all, with an expected slowdown lurking around the corner, the recent backup in wage gains may prove short-lived, not to mention the improvements appear to be more concentrated in particular areas where specific skills are in high demand and low supply, such as IT and engineering, as opposed to broad-based wage improvements across sectors."

That weakness, combined "with waning fiscal stimulus and the worst retail sales month in nine years, the consumers' health and well-being remains a primary concern," she added. "As a consumer-based economy, a negative shift in sentiment among consumers or a decline in consumers' mood reinforces the Fed's outlook for a reduced growth and inflation profile for the U.S. and the need for continued patience.

"In other words, the more hawkish faction at the Fed just lost a significant amount of wind in their sails heading into the March meeting as the majority of monetary policy officials tout patience, data-dependence and preparation for rising economic and geopolitical risks," Piegza said.

She expects "the next policy adjustment [to be] potentially a rate cut in the next 12 months."

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Monetary policy Jerome Powell Federal Reserve FOMC