Know When to Hold ‘Em, Know When to Halt ‘Em
by Craig Dismuke, Dudley Carter
January 2019 FOMC Meeting Minutes
The Fed did an about-face on its policy stance in January by opting to replace a bias for future rate increases in its Official Statement with a plan for patience before determining what rate “adjustments” might be warranted. The dovish decision caught investors on their heels and resulted in markets pricing out any chance of another rate increase for the foreseeable future. The Minutes from that meeting shed more light on why the Fed made such a sudden change, highlighting an increased amount of uncertainty and tame inflation. Moreover, the Minutes detail more progress on future balance sheet plans with surprising news that the runoff could conclude before year-end.
Transitory (Hopefully) Shift in the Balance of Risks
The Fed described growth as solid in January, a downgrade from the strong rate in December, and “participants noted that some risks to the downside had increased.” In December, participants were concerned about 1) weaker global growth, 2) further tightening of financial conditions, and 3) trade tensions. Added to that list in January was more uncertainty from foreign and domestic government policies, including Brexit and U.S. shutdown risks. At the same time, participants seemed more concerned in January about inflation falling below the 2 percent target than moving above it. A few were concerned, not just that inflation expectations might remain low as they were in December, but that inflation expectations would remain so low as to be inconsistent with the Fed’s policy objectives. Lower oil prices, weaker activity outside of the U.S., and an appreciating Dollar were all credited for keeping a lid on inflation. Further illustrating the shift in tone, the list of upside risks was largely dropped from the January Minutes. Specifically stated, “several participants judged that the risks that could lead to higher-than-expected inflation had diminished relative to downside risks.” The only upside risk explicitly mentioned seemed obligatory, that the downside risks might abate more quickly than expected.
What We Need Is a Little Patience
As a result, the Fed believed those dynamics “supported a patient approach to monetary policy.”
The Minutes went on to list areas of recent weakness or uncertainty that could become more clear over time, reading as a virtual dashboard for future policy decisions: weaker business sentiment, a drop in consumer sentiment, weakness in core and headline inflation and inflation expectations, the unknown impact of tighter financial conditions on real economic activity, the economic effects of the government shutdown, the future path of fiscal policy, the delayed impact of tighter monetary policy, uncertainty surrounding international trade policy, and the weaker state of the global economy (specifically that of the E.U. and China).
Additionally, the Minutes gave supporting reasons for why patience does not appear to be risky at this time, including that the current target rate range is near the estimates of neutral, inflation pressure remain muted, and asset prices appear to be less frothy.
Just a Little Patience
However, a hold is not a halt. Many of these areas of uncertainty could be resolved in fairly short order. Already, the government shutdown has concluded and funding has been secured for the remainder of 2019. Business sentiment and consumer sentiment have already shown signs of rebounding, which could implicitly answer the questions about the impact of financial market volatility on the real economy. And trade policy could be cleared up at any time. Further confirming that the current pause is not necessarily the end of the rate-hike cycle, there continued to be many officials who believed the outlook, including the new “patient” language, would need to be altered “if uncertainty abated.” Additionally, several officials believed a rate increase would be necessary later this year if growth played out as expected. In contrast, “many participants suggested that it was not yet clear what adjustments … may be appropriate later this year” and several noted that inflation would need to be above their baseline expectation before they would view another rate hike as appropriate.
Portfolio Runoff May End by Year-End
The plan for normalizing the balance sheet was also heavily discussed, with “almost all participants” saying “it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.” This idea of ending portfolio runoff by year-end was one of the few pieces of new information in the Minutes. Although officials seemed unconvinced that the normalization had had a major impact on markets, they conceded that some investors begged to disagree. “Participants agreed that it was important to be flexible,” and make that belief public. The discussion showed preference for a regime of abundant reserves, along with a buffer above estimates of the required level necessary to execute monetary policy, to guard against undesirable market volatility. The Committee discussed their plan for a portfolio primarily consisting of Treasurys, but a more detailed plan of what reinvestments might look like once run-off has ceased appears to still be in the works.