An Important Summer is Shaping Up in Washington

They say “Sell in May, and go away.” However, if you do that this year you are likely to miss a lot. The upcoming June 13/14 Federal Open Market Committee meeting is shaping up to be eventful. Also, the Trump Administration is sharpening its pencils and getting to work on tax reform. National Economic Council Director Gary Cohn expects to deliver a detailed plan to Congress by the end of summer. We also look forward to seeing more details of the President’s infrastructure plan in the coming months.

Despite the clunker of a jobs report for May, we expect the Federal Reserve to raise the fed funds rate range by 25 basis points for the second time this year on June 14. Most recent U.S. and global economic data have been positive, and the weaker-than-expected 138,000 jobs increase in May looks like a fluky number. As of June 6, the fed funds futures market views a June 14 rate hike as nearly a sure thing, with an implied probability of 96 percent. In addition to a rate hike on June 14, we expect to learn more about the FOMC’s thinking about future rate hikes, both for the remainder of 2017, and also for 2018. This could come in the form of forward guidance in the monetary policy announcement on June 14, added details from Janet Yellen’s post-FOMC meeting press conference, and from the updated “dot plot.”

In the near term, we expect the Fed to raise the fed funds rate one more time this year after June 14, for a total of three, 25 basis point rate hikes in 2017. The two leading candidates for the dates of the third rate hike this year are September 20 and December 13, which coincide with scheduled press conferences by the FOMC chairwoman Janet Yellen. There is an FOMC meeting over October 31/November 1, but that meeting does not coincide with a press conference. Given the need for the Fed to communicate clearly about interest rate policy and balance sheet reduction, the odds of a significant move coming from the Fed on November 1 appear to be low.

The timing of the third rate hike in 2017 will be coordinated with the Fed’s plans for balance sheet reduction. The Fed will likely take a pause from interest rate hikes to begin balance sheet reduction, which is expected to be equivalent to a marginal tightening of monetary policy. We look for the Fed to provide some more information about balance sheet reduction on June 14. So far, they have said that they would like to start reducing the pace of reinvestment of maturing assets this year (this will begin to reduce the size of the Fed’s balance sheet). They would also like to gradually ramp up caps on reinvestments until they reach their targets, and hold the caps constant until they reach the desired size of their balance sheet. We still need to know the start date of the reinvestment caps, the scale of the caps, the mechanisms of asset roll-off and the desired final size of the Fed’s balance sheet. Right now, we are expecting to see about a $1.5 to $2 trillion reduction in assets by the Fed, to occur over about a five-year period. We need further insight into the mechanisms for Treasury bond roll-off and for mortgage-backed-security roll-off in order to understand how new Fed policy will impact financial markets and bank financial flows by the end of this year.

The Trump Administration may begin to fill some of the vacant seats on the Board of Governors this summer. Janet Yellen appears to be heading toward retirement next February. Her replacement may be vetted this fall.

For a PDF version of the complete Comerica U.S. Monthly with additional commentary, tables, and charts, click here:  US_Economic_Outlook_0617.

 

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