At Last

At Last

At last, the Federal Reserve has begun the long march upward toward a New Neutral destination.

There were at least five surprises in the 556-word statement, and all of them tilted toward the dovish hike that many in the markets – and PIMCO – had expected. But the statement was even more dovish than I, for one, anticipated. Indeed, it read to me like Fed Chair Janet Yellen got her way at the meeting on all the key issues.

Issues that until now had been discussed in the context of her personal views are now the official policy – the “unanimous” vote today by the Federal Open Market Committee (FOMC) was one of the surprises. I had thought, for example, that at least Chicago Fed President Charles Evans might dissent, based on his view that the Committee should pay more attention to “actual” inflation and less to the Fed’s econometric model forecasts. This is a theme that Fed Governor Lael Brainard had also stressed in her recent speeches. It appears that to win these individuals’ support, the FOMC with Yellen’s urging now is on record as closely monitoring “actual” inflation.

Interestingly, the Board of Governor’s Summary of Economic Projections (or “blue dots”) marked down slightly the projection for inflation in 2017 – albeit by only 0.1%, but noteworthy in direction. The most important new word in the statement is the reference that the liftoff path will likely be “gradual.” Again, this is a term Yellen has used before but had been absent in the statements until now.

The statement also reminds us that the policy path will be “informed” by incoming data. Is it too much to conjecture that a policy informed by data is more gradual than one that is “data dependent”? Finally, the statement tells us that the Fed will continue to reinvest the proceeds from maturing securities in its portfolio until the normalization is “well” underway.

As for the blue dots, I did not expect that the median dot for 2016 would shift down. This dot implies up to four hikes next year. The FOMC values this optionality and did not want to trade it away. That said, I do expect the longer-run dots to continue to drift down in coming meetings. Three years ago, the Fed thought the longer-run destination for the fed funds rate was the old neutral of 4.25%. They now are centered around 3.5%, with two dots now at the upper end of PIMCO’s New Neutral range. Expect more dots to shift down in the years ahead.