Economist's Insights

Economic Flash: Minutes Show “Many” Officials Expect Another Near-Term Hike, But Unanswered Questions Surrounding Inflation Trends Make the Longer Outlook More Difficult

Nov 22, 2017

As expected, the Minutes from the FOMC’s November meeting included no discourse that should dislodge the market’s expectations for the next rate hike to come in December. In fact, the Minutes showed that “many participants thought that another increase in the target range for the federal funds rate was likely to be warranted in the near term if incoming information left the medium-term outlook broadly unchanged”. The discussion of economic activity was mostly upbeat. This more optimistic tone flowed through to the post-meeting Statement in the form of an upgraded economic assessment. Economic activity that was seen as “rising moderately” at the September meeting was seen as “rising at a solid rate” during the intermeeting period ahead of the November meeting. Ignoring a storm-disrupted September figure, the labor market had continued to add jobs at a pace that exceeds what the Fed expects longer-term and the unemployment rate was at a 17-year low of 4.2%, well below the Fed’s longer-run projection of 4.6%. As a result, the labor market – excluding disappointing wage gains – remained the least of the Fed’s worries.

 

As a result, the focus has been on the inflation half of the dual mandate. At the time of the meeting, the Fed’s favorite inflation measure, the PCE price index, was well below the 2%-target at 1.6%; the core measure had held at 1.3% for two months. In the Statement, the Fed acknowledged the weakness and in recent Fedspeak, including Tuesday night comments from Fed Chair Yellen, the uncertainty and confusion created by the recent slowdown in inflation has been all the buzz. In the Minutes, the lack of clarity on the cause of the Fed continually coming up short of meeting its inflation goal remained evident:

 

  • “Many participants judged that much of the recent softness in core inflation reflected temporary or idiosyncratic factors and that inflation would begin to rise once the influence of these factors began to wane. Most participants continued to think that the cyclical pressures associated with a tightening labor market were likely to show through to higher inflation over the medium term.”
  • But…”many participants observed that there was some likelihood that inflation might remain below 2 percent for longer than they currently expected, and they discussed possible reasons for the recent shortfall.” Those reasons included a weaker or greater lag in the responsiveness of inflation to resource utilization and potentially unmeasured labor slack. The impact of technological innovation was also brought up again.
  • One of the Fed’s worries is that “the persistently weak inflation data could lead to a decline in longer-term inflation expectations or may have done so already”.
  • This disagreement led to some believing “that the removal of policy accommodation should be quite gradual” while “some other participants were concerned about upside risks to inflation in an environment in which the economy had reached full employment and the labor market was projected to tighten further,”.
  • As noted earlier, “many” expect a near-term hike but “few other participants thought that additional policy firming should be deferred until incoming information confirmed that inflation was clearly on a path toward the Federal Open Market Committee’s symmetric 2 percent objective.”
  • In recent remarks, a couple of Fed officials have discussed exploring other policy frameworks (e.g. price-level targeting) that could potentially be more beneficial than the current framework. This discussion also made it into the Minutes, as “a couple of participants discussed the possibility that potential alternative frameworks for the conduct of monetary policy could be helpful in fulfilling the Committee’s statutory mandate.”.

 

Bottom Line: The November Minutes included nothing that should alter the expectation for the next rate hike to occur in December. The markets reflected a similar interpretation as near-term fed funds futures contracts held steady. However, the Minutes also included no evidence that the Fed has anymore clarity on what’s driven inflation lower this year. This unanswered question leaves open the possibility for the rate path further out to differ from what the Fed currently expects. The markets reflected a similar interpretation based on the move lower in fed funds futures’ implied rates further out, longer Treasury yields, and the Dollar; on balance, a reflection of a net dovish market take on the full set of Minutes. The inflation weakness will remain the primary concern for Fed officials until the data shows evidence of the metrics turning higher. As evidenced in the Minutes, some at the Fed would like to wait for this to occur before tightening much more. However, the slow and steady decline of the unemployment rate further below the Fed’s longer-run target is making that waiting game increasingly uncomfortable for others. The next few months could be telling in what is stronger: the Fed’s faith in the Phillips Curve or their fear of potentially forcing inflation lower.