FOMC meeting minutes will be out shortly
FED meeting minutes will be out shortly.The "Powell Call": What Do We Need To See For The Fed To Hike Again
There was significant shock two months ago when Powell made public the Fed's dramatic dovish reversal, effectively ending the Fed's rate hiking trajectory and at the same time unleashing a dramatic market rally. But why? Perhaps it has to do with the popular view that the Fed has an advantage in forecasting and in some cases has "inside information". In fact, as BofA notes, the Fed's forecasting accuracy is on par with that of market consensus, in other words rather dismal, and swayed more by the market than underlying fundamentals.
To assess the Fed's forecasting record, BofA looked at two sets of forecasts: the Board of Governors staff forecasts (Greenbooks) and the FOMC's summary of economic projections (SEP); whereas the academic literature has focused on the former, BofA examines the SEP forecasts from 2009 to the present.
What it found is that when looking at forecasts for real GDP growth, the unemployment rate and core PCE inflation, the forecast errors increased over time across the board (Chart 3). No surprise. The errors are the largest for GDP, which means that the Fed has the poorest record for estimating GDP. Comparing the forecast errors of the Fed vs the Blue Chip and Bloomberg consensus shows that they are comparable. Focusing on GDP, both the Fed and the consensus has underestimated GDP growth one to two quarters out over this recovery but has significantly underestimated growth thereafter (Chart 4).
Naturally, the Fed's infamous "dots", or fed funds projection, will be a function of these forecasts. Given the errors in forecasting growth and inflation, BofA notes that investors should be cognizant of the challenges in predicting the rate path.
Fed Chair Powell has been alluding to such, arguing that market participants shouldn't overemphasize the path of the dots given that they are only modal forecasts. Nonetheless, they are part of the Fed's communication strategy and will be under the market microscope in this world of enhanced transparency.
Of course, the current episode in which the Fed unexpectedly hit the breaks on its hiking intentions has striking similarities to what happened in early 2016 when the Fed delivered a hike in December 2015 during a period of heighted uncertainty in markets. Shortly thereafter, the markets and economy were hit by the combination of the surprise renminbi devaluation in August 2015, falling oil prices, Brexit and a rapidly strengthening dollar. Indeed, both Powell and Yellen have recently made parallels between the two episodes with Yellen explicitly stating in a recent CNBC interview that "what's going on now reminds me a lot of 2015/2016."
The Fed's communication shifted quickly back then as well: in December 2015, the minutes focused on the improvement in the labor market and strong growth prospects. By March, the Committee underscored that "global economic and financial developments" posed risks. Indeed, the dots went from 4 hikes to 2 hikes for 2016 between the December and March meetings. The rapid shift in Fed guidance prompted many market participants to argue that the Fed was "one and done" (it was merely put on hold for about a year).
The Fed then stuck with this dovish narrative until the April 26-27 meeting where they again signaled that hikes were on the horizon. But market participants were not pleased and further priced out the possibility of a hike. Finally by the summer, the market moved toward pricing in another hike at year-end as shown below.