There was something odd in the projections that Federal Reserve officials issued last week.
Enough policy makers bumped up the number of interest-rate hikes they expected in 2017 to lift the median to three from two — displayed graphically in the Fed’s so-called “dot-plot.” The Dec. 14 surprise, accompanying the Fed’s decision to raise rates for the first time in a year, pushed stocks off their record highs and lifted bond yields and the dollar.
But the accompanying economic forecasts barely budged. Compared to their September outlook, the median estimate for growth next year edged up by just one-tenth of a percentage point to 2.1 percent, the expected unemployment rate at the end of 2017 dropped a tenth to 4.5 percent and the inflation call remained unchanged at 1.9 percent.
“The overall picture is quite inconsistent,” said Thomas Costerg, senior U.S. economist at Standard Chartered Bank in New York. “It tends to undermine those dots. What is the message you are trying to convey?”
The dissonance contained in the Fed’s quarterly Summary of Economic Projections has caused some economists to scratch their heads over what’s behind it, and over what’s the truer signal of Fed intentions: the more hawkish message from rate projections, hinting at a greater readiness among policy makers to tighten policy in response to even modest economic progress, or the steady-as-we-go forecasts that line up with past patience toward adjusting rates.
John Bellows, a portfolio manager at Western Asset Management Co. in Pasadena, California, said the difference may result, in part, from the prospect for expansionary fiscal policies under the incoming administration of President-elect Donald Trump. That, he said, may have worked its way into Fed officials’ rate outlooks without yet causing them to rework their economic forecasts.
Costerg added that policy makers may have factored in rising stock prices since the presidential election. From Nov. 8 through the first day of the Fed’s meeting last week, the S&P 500 Index rose 6.2 percent.
“It may have been that stocks did play a role, and risk assets played a role, in turning people more hawkish even though they believed it was not yet time to change the forecasts,” he said.
Roger Aliaga-Diaz, a senior economist at money manager Vanguard Group Inc. in Valley Forge, Pennsylvania, said the move in the dots simply catches up with a strengthening of the economy that’s been ongoing for several months and could have justified a rate hike as early as September.
Further complicating the issue, during her press conference following the Fed’s two-day meeting, Chair Janet Yellen said some officials, but not all, had begun to incorporate assumptions about prospective fiscal policies under Trump into their forecasts.
While no round of Fed offficials’ quarterly estimates has a uniform set of inputs, the potential package of fiscal stimulus coming under Trump represents an unusually large and unknown factor for the Fed, according to Thomas Simons, an economist at Jefferies LLC in New York. It would have been better, he said, if they had all excluded it. In that case, at least economists would have the Fed’s baseline forecast excluding fiscal changes.
Providing a mixed bag “nullifies the quality of the forecasts,” he said.
Yellen did provide some guidance by playing down the significance of the move in the dots, calling it a “modest adjustment” that involved only “some of the participants.”
At the same time, the chair talked up the strength and resilience of the economy and stated clearly that fiscal stimulus wasn’t needed to get the labor market back to full employment, statements that align better with the dots than the forecasts.
Luke Tilley, chief economist at money manager Wilmington Trust Corp. and a former staffer at the Philadelphia Fed, cautioned against trying to draw too much from inconsistencies between the forecasts and the dots.
For starters, he said in an e-mail, changes in the dots were “less a reflection of any change in participants’ forecasts of growth or inflation, but more a reflection of their confidence in those views.”
He also pointed out that the rate projections are not simply an extension of a fixed forecast. Each can influence the other. For example, if an official expects higher economic growth, causing them to raise their projected rate path, that could, in turn, lower their expectations on growth and inflation.
When you dig deep into Fed projections, Tilley said, “it gets very challenging to pick apart the SEP.”