Fed is leaving a dovish regime – Deutsche Bank

Research Team at Deutsche Bank, suggests that the post-crisis years have been characterized by a dovish Fed and now there are several indications that the Fed is in the early stages of leaving this dovish regime behind and could take on a more hawkish stance going forward.

Key Quotes

“The first piece of evidence comes from a regime switching model, which identifies whether the Fed is in a dovish, neutral or hawkish regime based on how much the current fed funds rate deviates from traditional policy rules. This analysis suggests that the Fed's policy stance has turned more hawkish in recent quarters. Specifically, the model indicates that the odds of the Fed being in a dovish regime have fallen for the first time since 2013. Current estimates are of a one-third probability that the Fed is in a neutral regime, and "only" a two-thirds probability of still being in a dovish regime. The Fed has clearly not yet become hawkish according to this metric, but we are seeing early signs of this shift occurring.”

“The second metric we consider is our Hawk-Dove Score, which quantifies how hawkish or dovish FOMC statements are over time. The three-month moving average of this score has risen to slightly hawkish, from very dovish as recently as mid-year. This is the most hawkish reading for our metric in about five years. In the past, changes in Fed language have tended to act as a leading indicator for market expectations for the Fed and actual Fed policy.”

“If this shift continues, it could have important implications for the future path of Fed policy. A less dovish Fed would be reluctant to pursue a policy that risks an overheating economy that would eventually require a more abrupt policy tightening. Such a Fed would be more likely to raise rates preemptively. Chair Yellen's recent Congressional testimony raised this point as well. The question of whether this shift continues, becomes even more critical with prospects for a substantial fiscal stimulus program at a time when the economy is very close to the Fed's dual mandate objectives of full employment and 2% inflation.”