As argued in the first paper, a Fed hike next week seems like a done deal and if so, we believe attention will quickly shift to the updated Fed projections and, in particular, the so-called 'dots' illustrating the individual FOMC members' views on the future rate path for the Federal funds rate.
We expect the median 'dot' for 2016 to be revised down from 1.375% to 1.125% (from four to three hikes) and the median 'dot' for 2017 to be revised down from 2.625% to 2.375% (from five to four hikes). This is more hawkish than market expectations, as markets have priced in only approximately five hikes until year-end 2017.
Due to the rotation of voting Regional Fed presidents, we expect the voting FOMC members to become more divided between doves and hawks next year. However, most of the board members have a dovish-to-neutral view (three to four hikes in 2016 based on September 'dots').
The recent change in FOMC members makes the shift in the median more uncertain. In particular, watch out for the nominations for the two vacant seats on the board of governors (voting members).
Several FOMC members have indicated the Federal funds rate will be increased in a non-mechanical way and that the future rate path will be data dependent. This is closely related to the concept of the so-called neutral real interest rate, which is core to the Fed's theoretical thinking. The neutral real policy rate helps to explain why we expect the Fed to increase the Fed funds rate more slowly and why it is likely to stay lower than in previous cycles.
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