A SEPtember to Remember?

By: Jake Remley
September 19, 2022

All eyes will be on the Fed at 2pm on Wednesday.  Will they hike 50, 75, or (gulp) 100bps? What isn’t as discussed in the popular media is their Summary of Economic Projections (SEP) which includes not only their DOT plot, but clues as to their longer-term thinking about the economy and inflation.

“The future ain’t what it used to be.” – Yogi Berra

On Wednesday at 2pm, the Fed will release their highly anticipated policy rate decision. They will also post their quarterly Summary of Economic Projections (SEP) on their website.  This report is a compilation of participants’ economic forecasts on growth, unemployment, and inflation.  It also includes projections of the future path of policy rates based on those forecasts.  While the mainstream media obsesses over the size of Wednesday’s hike, fastidious Fed watchers can’t wait to dive into the SEP report, to search for clues regarding the Fed’s longer-term thinking.  Here are five thoughts to that end:

  • June’s SEP Report revealed the meeting participants’ distribution of forecasts for GDP, unemployment, and inflation. The consensus view was that inflation will taper in late 2022 and return to their comfort zone of 2-2.5% by the end of 2024.  It also revealed participants’ projected paths for policy rates, along with their longer-term rate forecast.  This last projection is effectively an estimate of their “neutral rate,” or the rate they believe balances maximum employment with price stability in perpetuity.
  • The medians of these policy rate estimates comprise the Fed’s Dot Plot. In the June report, the estimated path was 100-150bps higher than that of the March report, except for the longer-term rate projection which was effectively unchanged at 2.5%. Interestingly, today’s Fed target rate is 2.5%, yet prices across the economy remain far from stable.

  • If the September SEP report shows participants have moved their longer-term rate estimate meaningfully higher, it may be a sign of a change in Fed thinking about this inflation conundrum. They dropped the word “transitory” from their inflation speak months ago, but they have yet to admit it has at least a portion of its roots in lasting structural shifts.  They continue to speak as if this inflation problem is cyclical in nature, and they can eventually nudge the economy back to pre-pandemic conditions with conventional monetary tools.
  • Structural inflation arguments are buttressed by growing evidence of stagnation in the workforce. This is a byproduct of the lasting societal impact from the pandemic, aging demographics, and realigned supply chains.  The key point is that these factors won’t wash away with gentle undulations in the economic cycle.  Their destabilizing impact on prices can be rectified, but history suggests it’ll take a major economic restructuring (i.e.,o recession) to get it done.
  • Buried in the second half of the SEP report are the summaries of participants “risk skews” to their estimates on unemployment, growth, and inflation. These skews are broadly categorized as “weighted to the downside”, “broadly balanced”, or “weighted to the upside”.   In June, most participants noted that the risk skew to economic growth estimates were “weighted to the downside” while inflation estimates were “weighted to the upside.”  March was similar.   Not coincidentally, the Fed has responded to data in an increasingly hawkish fashion over that timeframe (remember when 50bps was considered a jumbo hike?).  Should we expect this hawkish tilt to persist over the next three months?  Hopefully not if the Fed truly believes that inflation has peaked, and a soft-landing is achievable. But that would imply the risk skews move to “broadly balanced” in Wednesday’s SEP report.  The August CPI report released last week put a serious dent in that hope.

These are the Fed tea leaves we’ll be looking at on Wednesday. Naturally, Powell’s answers at the presser will fit into the mosaic as well.  At IR+M, we don’t position our strategies around specific outcomes at a Fed meeting, but we use their clues to assess how long this sustained market volatility may last from here – especially as it applies to our pace of buying as well as our overall risk posture going into year end.  After all, getting the timing right is the hardest part.

Source:  Federal Open Market Committee Summary of Economic Projections; www.federalreserve.gov