FOMC: On a Fast Track to Normalisation

The FOMC decided to raise the fed funds rate to 0.75% on December 14th, and have pencilled in an extra rate hike in 2017. The media would have us believe that the faster pace of normalising the policy rate to its long term norm now estimated at about 3% reflects both a stronger US economy and expectations of outsized fiscal stimulus under a Trump presidency. Neither of these conjectures is correct. Indeed, it appears that the staff forecast, which heavily influences the views of most FOMC participants, is essentially unchanged from the September version. In my opinion, incoming data including the upward revision to Q3 GDP along with the strength of employment, earnings and household spending in Q4 can explain virtually all the small upward revisions to economic activity in both 2016 and 2017. Only the tiny revision to GDP growth in 2019 might be interpreted as a nod in the direction of incorporating more government spending or tax cuts under Trump, but I doubt that as well. The staff does not deal in speculating about future fiscal policies. Rather, its public sector forecasts are based on actual outlays and receipts coupled with data on congressional appropriations, none of which has occurred yet.

The staff forecast process begins with revisions to the current level of GDP based on data revisions and incoming data. In this case, many of the latest numbers have surprised forecasters to the upside, as has the sharp decline in the unemployment rate to 5.6% in November. Data on the labour market, especially the payroll survey, carry a heavy weight in the current quarter estimates at least until other flow data becomes available. Not only is employment the most up-to-date data, it also is tell-tale because of the simple notion that employers do not hire workers unless business is good. An upward revision to Q4 GDP also tends to have some carry-forward into the Q1 level of GDP in the staff’s forecast exercise, thereby explaining the small 2017 revision. That leaves the tiny revision to 2019, which is hardly worth mentioning. At 1.9% that forecast remains at or below the US long term potential growth of about 2%, which in itself is at the high end of the staff’s latest estimate of 1.5% to 2%.

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