Pay Attention to These Words and Dots: Fed Decision-Day Guide

Most Important Two Minutes of Yellen's Statement
  • Clues on unemployment and Brexit views may be important
  • Dot-plot update may reflect slower rate hikes in 2017, 2018

Chair Janet Yellen’s Federal Reserve wraps up a two-day meeting on Wednesday in Washington. Officials are expected to debate whether the economy can handle another interest-rate increase after they hiked in December for the first time in almost a decade.

The Federal Open Market Committee’s deliberations come as the central bank receives conflicting signals about the economy’s strength: A comprehensively weak May jobs report contrasts with strong spending. Economists and investors don’t expect a rate increase this week, and will look to the Fed’s statement, quarterly economic projections and Yellen’s press conference for hints at future timing and pace.

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Here’s what to watch for when the Fed releases its statement and economic projections at 2 p.m. and Yellen speaks at 2:30 p.m in Washington.

Labor Market vs. Growth

“...labor market conditions have improved further even as growth in economic activity appears to have slowed.” -- April 27 FOMC statement

Fed officials will almost certainly revisit the statement’s first sentence, because job gains have slowed -- averaging 81,000 per month in April and May, after a pace of 196,000 in the first quarter -- even as consumer spending accelerated and confidence has remained high. A strong consumer should help economic growth rebound in the second quarter after a lackluster start to 2016.

What’s really important is how Fed officials characterize the labor market change: Do they see it as a blip, or a more fundamental slowdown? If they’re looking for more clarity, how much more data do they need to see?

“We will be looking for exactly how they detail the recent weakness in the economy,” said Lindsey Piegza, chief economist at Stifel Nicolaus & Co. in Chicago, specifically pointing to the labor report. “The Fed will be much more willing to jump back on the bandwagon of a near-term interest rate increase if they see this as isolated.”

The Dots

The Fed’s so-called “dot plot,” released alongside the statement with quarterly economic forecasts, shows the pace of interest-rate increases that central bank officials expect will be warranted. In March, the median projection fell to two quarter-point hikes this year, versus a prior expectation for four.

If that falls further, it could be an important dovish signal. If officials maintain the call for two increases at a time when markets are looking for no more than one, they could force investors to reassess.

Fed officials in March also projected four rate hikes in both 2017 and 2018. Any further reduction would show tightening will be even more gradual than the already-slow pace they’d anticipated.

Goldman Sachs economists Zach Pandl and Jan Hatzius expect the median fed funds rate outlook for this year will be unchanged and the pace of later increases will probably come down.

“The risks to the 2016 projections are likely skewed to the downside: if many participants see September as the appropriate time for the next rate increase, they may only show one hike for the year, as there may simply not be enough ‘time on the clock,’” they wrote in a research note last week.

Brexit Outlook

“The Committee continues to closely monitor inflation indicators and global economic and financial developments.” -- April 27 statement

A potential British exit from the European Union will loom ominously over the June meeting. It could be one factor dissuading policy makers from hiking rates, and may prompt them to tweak the global-developments portion of their statement -- though they probably won’t address it by name.

The U.K. is holding a referendum on whether to remain in the EU on June 23, and volatility is stirring in global markets as more polls lean toward a “leave” vote.

The Fed demonstrated last September that it reacts to global financial developments, which can affect both credit conditions in the U.S. and demand for American products abroad. Yellen earlier this month said that a Brexit could “shift investor sentiment” and might carry “significant economic repercussions.” There’s a good chance she’ll be asked to comment further in her post-meeting press conference.

Inflation Expectations

“Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.” -- April 27 statement

The Fed might revisit its take on inflation expectations: In a June 6 speech in Philadelphia, Yellen said that “it is still my judgment that inflation expectations are well anchored” but “continued low readings for some indicators of expected inflation do concern me.” Days later, the University of Michigan’s survey showed that consumers’ long-term inflation outlook had fallen to the lowest level in records that go back to 1979.

Neil Dutta, head of U.S. economics at Renaissance Macro in New York, called the inflation expectations language “the key thing to watch” at this meeting, writing in a research note that if it’s little changed, it would “be sending an unnecessary hawkish signal to the capital markets.”

Actual Inflation

“Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further.” -- April 27 statement

If inflation expectations are getting the Fed down, price pressures themselves should provide a salve. The Fed’s preferred inflation index has averaged 1 percent so far this year, still below the committee’s 2 percent goal but way better than the 0.3 percent average in 2015. What’s more, energy prices are moving back up and dollar strength has waned a bit.

Yellen’s Tone

When Yellen delivers prepared remarks and takes questions, investors will be watching for more clarity on the what the statement means. Crucial: any clue about whether July is on the table for a rate hike or whether the Fed will need more than one month’s data to determine whether the economy -- in particular the labor market -- is holding up. That’s what Gennadiy Goldberg, interest-rate strategist at TD Securities LLC in New York, said he’ll be looking for.

“Does one good payroll report start to show you that the trend is moving higher again?”

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