FOMC September Minutes
by Craig Dismuke, Dudley Carter
Strong Economy and Near-Two-Percent Inflation Could Lead to Restrictive Policy
The Fed’s September Minutes reaffirmed that “strong” economic growth and inflation “near 2 percent” warranted the hike in September and projections for “further gradual increases” in the quarters to come. This plan “would balance the risk of tightening monetary policy too quickly, which could lead to an abrupt slowing in the economy and inflation moving below the Committee’s objective, against the risk of moving too slowly, which could engender inflation persistently above the objective and possibly contribute to a buildup of financial imbalances.” Despite the official risk assessment remaining “roughly balanced”, the overall tone seemed to lean slightly in favor of more optimism.
On Growth: A “few” said “recent data pointed to a pace of economic activity that was stronger than they had expected earlier this year.” In addition, the risk discussion included more upside risks (economic confidence, accommodative financial conditions, larger-than-expected fiscal boost, tighter resources, ability to pass costs increase to consumers) than downside risks (trade policy, stronger growth divergence driving the Dollar higher and growth and inflation lower, emerging market contagion).
On Inflation: With regards to inflation, “…participants viewed recent consumer price developments as consistent with their expectation that inflation was on a trajectory to achieve the Committee’s 2 percent objective on a sustained basis. Several participants commented that inflation may modestly exceed 2 percent for a period of time.” As to wages, which the Fed sees as key for sustained inflation, there was general agreement that there had been “some acceleration in labor costs” but the overall trend “remained moderate by historical standards.”
On Removing “Accommodative”: The Minutes showed “almost all” agreed to strike a sentence in the Statement that described policy as “accommodative.” There was agreement that it wasn’t a signal of the future path of policy, a fact that Powell made clear in his press conference when he pointed back to the neutral rate estimate being still three hikes away. Instead, the statement “had provided useful forward guidance in the early stages” of normalization but “was no longer providing meaningful information in light of uncertainty surrounding the level of the neutral policy rate.” Waiting much longer “could convey a false sense of precision” as to where the neutral level lies.
On Future Rate Increases: Another rate increase at the December meeting seems consistent with the call for “further gradual increases” and the coalescing of the dots around a fourth 2018 hike. As to 2019, the discussion could become more interesting in upcoming meetings. Based on the current neutral estimate, policy is projected to become restrictive in 2019. There were a “few” that believed “policy would need to become modestly restrictive for a time and a number judged that it would be necessary to temporarily raise the federal funds rate above their assessments of its longer-run level in order to reduce the risk of a sustained” inflation overshoot or creation of “financial imbalances.” Only “a couple of participants indicated that they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation.”
On Balance Sheet Normalization: The September meeting included what is expected to be the final adjustment to the roll-off caps to a total of $50B per month. The Minutes noted that the “market reaction to the ongoing reduction in the System’s holdings of Treasury and agency securities had been muted to date.” Absent a pickup in prepayments and “Under the baseline path for interest rates, the Federal Reserve’s reinvestments of principal payments on agency mortgage-backed securities would likely fall to zero beginning in October.” It was also noted, “As yet, there were no signs that the upward pressure on the federal funds rate relative to the IOER rate was due to scarcity of aggregate reserves in the banking system.”
Other Tidbits: Hurricane Michael was said to have caused “devastating losses” for the areas directly hit but was expected to have only a “relatively modest” impact nationally. The debate around the slope of the yield curve continued, and there remained a divide between those who believe it is still a relevant recession indicator and those who think this time is different.
Bottom Line: While there was nothing earth shattering in the Minutes, the tone seemed to lean towards more optimism and there are more than a couple of officials who believe policy could move above the longer-run neutral rate. Against the strong outlook described, the tone is likely to give markets slightly more conviction about a December hike and could cause them to reconsider expectations for 2019. In fact, Fed Funds futures’ implied rate, the Treasury curve, and the U.S. Dollar were all slightly higher after the Minutes.