FOMC Preview: Forward guidance tweaks and new inflation forecasts – The Fed concludes its September meeting this Wednesday, and is widely expected to make no changes to policy at this stage. More likely to make headlines are the Fed’s newly updated Summary of Economic Projections, and potential tweaks to the forward guidance in its policy statement. First, we think it is likely the Fed will alter its stated purpose of asset purchases, which as of the July meeting statement are said to be to ‘sustain smooth market functioning’. Given that bond and money markets have been functioning rather well in recent months, this had already been looking a little out of date at the last meeting, and the minutes from that meeting noted that ‘many participants’ thought it ‘might become appropriate to frame communications regarding the Committee’s ongoing asset purchases more in terms of their role in fostering accommodative financial conditions and supporting economic recovery.’ We therefore expect the Fed to adjust its language accordingly in the September policy statement. However, given the ongoing macroeconomic uncertainty – and the relative stability of financial markets – we doubt the Fed will be ready to give more explicit guidance on how much longer asset purchases will continue for at this stage.
The second key item to watch will be whether the Fed gives more explicit guidance on how long rates are expected to remain at low levels, and how this links to the outcome of the framework review (see our note on this topic here). Here, the Fed could state explicitly that it does not expect to raise interest rates until it has achieved its new average inflation target. This would represent an upgrade over the existing language contained in the July minutes, which states that rates would stay on hold until the Committee judges the economy is ‘on track’ to achieving its goals. While it would be logical to make such a clarification following the framework review, the Committee seemed noncommittal on this topic in the July minutes. As such, they may want to see first whether the new SEP projections – in combination with the new average inflation target – are sufficient in directing market expectations. They might also judge that a better time to give such guidance would be when the recovery is on a firmer footing, and there is greater certainty over the outlook – particularly given that the Fed isn’t even ‘thinking about thinking about’ rate hikes at this stage.
Finally, on the projections themselves, we expect modest upgrades to both the growth and inflation outlook, given that the recovery so far has been somewhat stronger than expected. The key focus for markets will be whether the Committee sees inflation rising above 2% at some point, which is possible with 2023 being added to the projections for the first time. Above 2% inflation will be a necessity at some point if the average inflation target is to be achieved (see chart below). However, we judge that at most the Committee will forecast 2% inflation, which – combined with the new target – should send a strong signal that rates will stay low for a number years to come. (Bill Diviney)