We expect the Federal Reserve will keep its policy rate in a range between 1.50% and 1.75% at the December FOMC meeting on Tuesday and Wednesday. The major interest of investors and policymakers will naturally be the movement in the dot plot, which we expect to move into alignment with the current policy rate, with 2020 to the midpoint of the current target range near 1.62%. The 2021 and 2022 rates, based on our model, should move toward 2.1%. This should provide some measure of comfort for investors who believe that there is a high hurdle for the Fed to raise rates despite the blowout November payroll numbers.
To put this in perspective, the current effective policy rate trades near 1.55% on a daily basis. Using a modified Taylor rule, that implies that the Fed’s estimate of the real neutral rate is somewhere near .25% and the nonaccelerating inflation rate of unemployment is 3.5%. Under current economic conditions, the Fed has ample room to remain accommodative, tolerate any upside deviation to inflation and still retain some power to respond to negative developments in trade tensions. In our estimation, this will essentially make the Fed a sideshow for the next few months as attention turns to policy risks around the trade conflict and the upcoming presidential election.
The only change we anticipate in the policy statement is going to be around the language describing the labor market, which will be somewhat more optimistic. Other than that, the language stating that “The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate” will not change. We expect no dissents
The ensuing news conference will not deviate too far from the recent statements by Fed Chairman Jerome Powell, who in our opinion has improved his policy communications noticeably over the past few months. Despite ongoing issues with the overnight repo market, we believe that there will be no new announcement of a standing repo facility despite end-of-the- quarter pressures. With the Fed likely to announce a change in its inflation target policy early next year, we expect that any announcement of a standing repo facility will be packaged with any change in the inflation target in 2020.