Dovish Fed, by Tim Duy: Coming on the heels of a dovish FOMC meeting and press conference, it might be surprising that San Francisco Federal Reserve President John Williams is still looking for two rate hikes this year. Via Bloomberg:
“We are getting closer and closer,” to raising rates, he told reporters on Friday after delivering a speech in San Francisco. Williams, a voter this year on the policy-setting Federal Open Market Committee, was head of research at the regional bank when it was led by now-Chair Janet Yellen.“My own forecast would be having us raise rates two times this year,” he said. “But that would depend on the data.”
Why raise rates this year despite anemic inflation and moderate economic growth? He still expects the Fed will be moving closer to its stated goals in the second half of the year and moving sooner means moving slower:
Williams also said that raising rates earlier rather than later would allow the Fed to tighten gradually, which he favors because the U.S. economy still faces significant headwinds.“If we raise rates sooner rather than later, then we can do it more gradually,” he said.
It is worth reiterating just how gradual the Fed is planning to raise rates. This I think remains more important than the timing of the first hike. Note that the midpoint forecasts from the Summary of Economic Projections imply a 0 percent equilibrium interest rate at the end of 2016, and just slightly higher than that in 2017:
And note that this is a somewhat more dovish projection than that made in March:
which was also more dovish than the prior SEP. Essentially, this Fed is jointly both hawkish and dovish - even as they warn they are moving ever closer to that first rate hike, they continue to push down the expected path of subsequent hikes. Persistently slow growth, low productivity, and low inflation are wearing on their outlook. Consequently, they continue to extend their expectations of a low interest rate environment. Policymakers are clearly moving toward market expectations in this regard.
Whether reality matches expectations remains an open question. Treasury rates have pulled up off their February lows, taking mortgages rates along for the ride. The Fed will be carefully monitoring this situation; they do not want mortgage rates in particular to climb ahead of the economy. The memories of the taper tantrum - and the subsequent stumble in the housing market - still sting. This time around, however, higher rates are being driven not by a shift in the expected Federal Reserve reaction function, but instead by an improved economic outlook. If housing markets can handle the higher rates (note the return of the first-time buyer), and there is reason to believe they will if wage growth continues to accelerate, then the Fed will feel more confident that they are getting across a message consistent with the evolution of activity. And they will thus be more willing to begin the normalization process in 2015 as they currently anticipate.
Policymakers would like to orchestrate a smoother transition to more normal policy than that of the botched tapering signal. This time around they are more clearly signaling a transition in which interest rates are moving in line with an improvement in the broader equilibrium that includes stronger wage growth and inflation closer to target. They learned a lesson from the taper tantrum of 2013: Make sure the signals you send are consistent with the path of activity. Learning that lesson speaks well for the sustainability of the recovery.
Bottom Line: Don't be surprised if you hear more Fed officials say they are still looking to rate hikes this year. Between being close to meeting their goals and the desire to move early to move slowly, the bar to hiking rates is probably not all that high. Watch instead for data that will either confirm or deny the Fed's near- and medium-term outlook. Seemingly paradoxically, that outlook has been increasingly dovish even as the countdown to the first rate hike ticks toward zero.