Goldman: The Fed Will Hike This Week, But Here Are "The Two Most Interesting Questions"

On Wedensday the FOMC will hike rates by another 25 bps – an event which the Fed Funds market prices in with near virtual certainty, while Goldman calls the rate increase “extremely likely” – and only a “tail” event like an extremely weak CPI report on Wednesday morning, hours ahead of the Fed announcement, has any chance of preventingthis outcome. So with the next rate hike virtually inevitable, questions are focused on not only the Fed’s exit strategy for balance sheet normalization and what the “dots” or funds rate path will look like, but how the Fed squares rising rates with the recent string of inflation misses.

As Goldman’s Jan Hatzius writes, data since the March meeting has sharpened the dilemma that both sides of the mandate are sending increasingly different signals about the urgency of further tightening. “The unemployment rate has fallen 0.4pp since the March meeting and our current activity indicator and real GDP estimates signal that above-trend output growth will produce further labor market improvement. But the year-over-year core PCE inflation is now 0.2pp lower than at the March meeting.”

While conceding that a hike is guaranteed, Goldman notes that two issues should make this meeting particularly interesting.

First, will Fed officials alter their policy views in response to the increasingly different signals that both sides of the mandate are sending about the urgency of further tightening?

Second, will the press conference provide some clarity on what the next tightening step following the June hike will be?

As a result of the weaker than expected inflationary prints, Goldman believes the recent data do not call for a major change in the Fed’s policy outlook. While Hatzius expects the FOMC to lower its estimate of the structural unemployment rate by a tenth next week, even with that assumption, the new data have broadly offsetting implications for the policy outlook in standard Taylor rules. Highlighting recent Fed communications, Goldman believes the Fed will follow “a balanced approach in dealing with the dilemma.”