June FOMC Minutes: Fed Hawks Win in Split Decision on Inflation and Balance Sheet Timing
Jul 6, 2017
On June 14, the Fed raised its target rate range by 25 basis points to 1.00%-1.25%. In addition to the rate increase, the Fed disclosed greater detail about the structure of the plan to slow reinvestments of cash flows from its portfolio holdings. In the updated projection materials the Fed kept its call for a three-hikes-a-year pace to a longer run rate of 3.00%. In her post-meeting press conference, Chair Yellen didn’t seem to be her usual dovish self, sticking with a sanguine outlook and a steady pace of projected tightening. However, this all occurred against a backdrop of softer economic data and a nascent weakening in core inflation. As such, there were two primary questions that market participants were looking for answers to in today’s Minutes:
Because the Fed hiked for a fourth time this cycle even as year-over-year inflation slowed for a fourth month – and kept its call for another hike this year and three more in 2018 – what did the Fed think about the softer inflation trends and why weren’t they concerned?
The Minutes showed that the full participant group, “in light of surprisingly low recent readings on inflation”, expected inflation to remain “somewhat below” the Fed’s target in the near term. “However, participants judged that inflation would stabilize around the Committee’s 2 percent objective over the medium term,” the Minutes showed. The reason – because “most participants viewed the recent softness in these price data as largely reflecting idiosyncratic factors, including sharp declines in prices of wireless telephone services and prescription drugs, and expected these developments to have little bearing on inflation over the medium run.” However, there are those that don’t agree; “several participants expressed concern that progress toward the Committee’s 2 percent longer-run inflation objective might have slowed and that the recent softness in inflation might persist.” The inflation doubters point to a break down in the Phillips Curve. As to the outlook for inflation, “some” see downside risks while just “a couple” see a tighter labor market creating “appreciable upside risk.” One thing they could agree on was that “the Committee should continue to monitor inflation developments closely.”
A plan for the structure of phasing out reinvestments was announced alongside the June rate decision, but there was a key piece of information missing. When will the Fed begin to slow their reinvestments?
The Minutes did little to clear up the question of when the Fed will begin to allow their portfolio to shrink. There were a “range of views” about when to implement the phasing out of reinvestments among the full participant group. The Minutes indicated “Several preferred to announce a start to the process within a couple of months; in support of this approach, it was noted that the Committee’s communications had helped prepare the public for such a step.” But there were those participants who supported a longer of a runway. “Some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation. A few of these participants also suggested that a near-term change to reinvestment policy could be misinterpreted as signifying that the Committee had shifted toward a less gradual approach to overall policy normalization.” Limiting it to just the voters, the Minutes simply stated that there was consensus for starting this year.
The Minutes also addressed how balance sheet normalization will impact the plan for additional rate hikes. Unfortunately for Fed-watchers, they could not agree on that either. Several said “the target range for the federal funds rate would follow a less steep path than it otherwise would” once cash flow reinvestment slowed. On the other side, “some other participants suggested that they did not see the balance sheet normalization program as a factor likely to figure heavily in decisions about the target range for the federal funds rate.”
Bottom line: The biggest news from the Minutes was the lack of news from the Minutes. As indicated in recent Fedspeak, there is a split at the Fed between those that think inflation is transitory and those that think something bigger is brewing. On the balance sheet, there appears to be a consensus for beginning to phase out cash flow reinvestments this year but there is disagreement on which particular month to put the plan in place. The lack of excitement could be seen in the market response. An initial rise in Treasury yields and the Dollar quickly faded and both returned to their pre-release levels.