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MACRO VIEW COLUMNS: Traders Focus on Fed Dots, But Do They Matter Now?

(Bloomberg) — It’s become fashionable to downplay the balance sheet adjustment set to be announced at Wednesday’s FOMC meeting and instead focus on the economic projections –particularly the infamous “dot plot” of Fed funds rate forecasts. After all, the small reduction to portfolio reinvestment has been well-flagged for what seems like years, whereas the projections offer fresh insight into the FOMC’s thinking, with potential implications for bond and currency traders. While it’s true that eliminating the rate hike penciled in for December would prompt a big reaction, it doesn’t necessarily follow that ratcheting down expectations in future years should substantially move markets, at least not beyond a day or two. Not only is the composition of the committee next year up in the air, but the market has already priced in a substantial markdown in the dots.

  • Although reasonable people can disagree about the ultimate impact of the Fed’s balance sheet policy, it’s hard to argue that the needle will move very much this week if the expected announcement comes to fruition. That’s not necessarily the case with the Fed projections, where there is uncertainty about how the FOMC will view the medium term growth and inflation pictures given the influence of transitory (and not so transitory) factors. As such, the “smart money” focus is where it usually is: on the nuance of the statement and the economic and policy projections
  • Given the ongoing shortfall in inflation and the disruptive influence of the current hurricane season, some degree of markdown seems likely. But to what degree? Will the Fed reduce its estimate of the long-run neutral policy rate? Will it take rate hikes out of the projections in 2018 and 2019, or even remove the last anticipated tightening this year? Inquiring minds want to know. It’s worth noting, however, that over the past few years there’s been little correlation between changes in inflation and changes in the dot plot
  • It’s important to acknowledge, moreover, that even with the recent rise in U.S. bond yields that there’s a lot of bad news in the price. Markets currently discount a little more than one rate hike over the next twelve months, compared with three projected by the dot plot. That’s the widest gap since this time last year, when the Fed revised its tightening projections sharply lower. Tellingly, market pricing for future tightening didn’t really budge when that happened. A similar outcome is likely this time around
  • Of course, the composition of next year’s committee will look very different from that in 2017. Not only do the regional presidents rotate more hawkishly, but of course new members of the board, and possibly the chair, will also enter the fray. This week’s projections, whatever they may be, should therefore be taken with a healthy grain of salt
  • NOTE: Cameron Crise is a macro strategist who writes for Bloomberg. The observations made are his own and are not intended as investment advice.

To contact the reporter on this story: Cameron Crise in New York at ccrise6@bloomberg.net

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