UBS: FOMC becoming more confident in its outlook

On growth, the Fed continued to see a solid household sector and an improving business sector, especially noting equipment investment increases in Q4 and faster new orders for capital goods in recent months. As at the prior FOMC meeting (when the Fed again tightened policy), FOMC members described a labor market that "had continued to tighten" and activity that "had continued to expand at a moderate pace. Their economic forecasts "had changed little since the December FOMC"—and unsurprisingly, FOMC members therefore sounded a bit more confident in their policy projections for the year.

However, they also again emphasized "considerable uncertainty" about the impacts and timing of fiscal policy changes—as they had in December. But on balance, " it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting … increased." It's fair to say that incoming information have been as strong as expected or perhaps slightly stronger. But the implication for policy is a hike "fairly soon" — and it's not obvious that "fairly soon" means March.

FOMC members are obviously considering the question of how much labor slack remains. In a classic Fed formulation, the FOMC minutes reported their thoughts on the risks around a too-hot labor market: "Many members continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly."

There were several parts to this:

1) FOMC members continue to consider, as Fed Gov Powell did today LINK , whether the participation rate could not rise further, and most participants still expected that the unemployment rate would run only modestly below their estimates of longer-run neutral.

2) The Fed would be able to respond in time, as Yellen has suggested.

Several risks to the policy outlook were listed: Upside risks such as "appreciably more expansionary fiscal policy" or greater inflation pressures; downside risks such as further dollar appreciation and "financial vulnerabilities in some foreign economies, together with the proximity of the federal funds rate to the effective lower bound." Those "financial vulnerabilities" appear to refer to the dollar-denominated debt held abroad that Fed Gov Brainard has been warning about: Non-US world debt denominated in dollars has increased sharply, so dollar appreciation increasingly spills over to foreign growth.

We continue to project rate hikes in June and December, but the likelihood of March continues to increase. Why not hike in March?

1) Fiscal policy uncertainty.

2) Bank lending has slowed sharply, although in contradiction to most indicators of activity.

3) The Fed remains confident enough that the labor force participation rate might rise further and that, in any case, undershooting on the unemployment rate would be acceptable.

4) The usual political risks surrounding foreign elections.

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