Caroline Baum: Is the Fed really ready to run with the bulls?

Three or four? That is the burning question on everyone’s mind as the Federal Reserve meets this week for the first time under the stewardship of its new chairman, Jerome Powell.

More important than the number of projected interest-rate increases this year, always in 25-basis-point increments, is how the Fed incorporates the effect of recently enacted tax cuts and spending increases into its forecasts for economic growth and inflation, and to what degree it intends to offset fiscal stimulus with monetary tightening.

After all, the Fed has said repeatedly that its 2% inflation target is not a ceiling; that price-level targeting, allowing inflation to exceed 2% to offset the chronic undershoot, is under consideration as an operating framework.

On Wednesday, we will learn from the post-meeting statement, the “dot plot” of individual projections for the federal funds rate, and Powell’s press conference just how serious the Fed is about turning its talk into action.

That inflation has failed to materialize as expected with the unemployment rate (4.1%) below the Fed’s estimate of full employment is reason enough to stick with a “still accommodative” policy, according to the handful of doves on the Federal Open Market Committee. For example, Chicago Fed President Charles Evans has repeatedly urged the Fed to wait to see inflationary pressures emerge before raising rates.

When policy makers met in late January, the Federal Reserve Board staff had already incorporated the tax cuts and elevated level of business optimism into its rosier economic outlook. Powell reflected that upbeat assessment when he testified before Congress in February.

“My personal outlook for the economy has strengthened since December,” Powell told the House Financial Services Committee on Feb. 27, citing a robust job market, strong global growth, signs of accelerating inflation, and “more stimulative” fiscal policy.

That was sufficient to prod many analysts to raise their fed funds forecasts from three to four increases this year from the current 1.25%-1.50% range. Another factor was a March 6 speech in which Fed Gov. Lael Brainard said the economy’s headwinds had turned to tailwinds. Fed watchers immediately moved Brainard’s dot from two to three. (You can’t make this stuff up.)

The Fed staff may be projecting stronger growth, but as of January, inflation wasn’t expected to reach the Fed’s 2% objective until 2020. (Core inflation, excluding food and energy, was projected to hit 2% in 2019.)

What about the idea of running the economy hot, of allowing — even targeting — 2+% inflation for several years to offset six consecutive years of sub-2% inflation?

Even with adequate communication, forewarning and stroking, it would probably turn out to be a case of ivory-tower theory getting mugged by reality.

It was only six weeks ago that the stock and bond markets TMUBMUSD10Y, +0.51%  had a hissy fit following the report of a one-month, outsized increase in average hourly earnings for a fraction of private-sector workers. January’s 2.9% increase was subsequently revised down, and the February 2.6% increase was back to the trend.

The problem with targeting, say, 2.5% inflation for several years is less one of affirmation than realization. It implies that the Fed knows how to hit its inflation target, no less move interest rates in the appropriate direction to achieve its goal. For years, the Fed has been coming up with excuses for below-target inflation — blaming transitory or idiosyncratic factors — even as it began raising its benchmark rate.

The fed funds futures market is putting a high probability of a 25-basis-point rate increase on Wednesday and another at the June meeting, according to the Chicago Mercantile Exchange’s FedWatch tool. The September odds are just above 50% while the December probability is only 37%.

It’s fine for markets to speculate and for the Fed to project, but as we are reminded frequently, monetary policy is not on a pre-set course but rather is data-determined. If you haven’t committed these platitudes to memory, you haven’t been paying attention.

Estimates for first-quarter real gross domestic product growth have been repeatedly slashed to the 2%-2.5% range due to weakness in consumer spending.

The Atlanta Fed’s GDPNow stands at 1.8%. Most economists still expect growth of almost 3% this year, but that could change if first- quarter weakness turns out to be something more than residual seasonality in the data.

Then there’s President Donald Trump’s decision to impose tariffs on steel and aluminum imports, throwing some “uncertainty” into the mix because of questions about implementation and likely retaliation by U.S. trading partners.

So will it be three or four rate increases this year? Even the Fed doesn’t know for sure. The Fed could leave us hanging, with half of the committee projecting three and half expecting four.

Remember, the dot plot is a snapshot in time: nothing more, nothing less. It’s the evolution of the dots, how and why they moved, that matters.

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