Fed Minutes Scatter the Birds and Dollar Rally Sucks Wind
A confusing set of minutes that say, on the one hand, many want to raise fairly soon, but on the other, many say there is likely to be ample time to respond if signs of rising inflation pressure emerge. Many want to emphasize a gradual rate tightening outlook, but several, it seems, want the Fed to appear more flexible. There are some hawks that are ready to hike soon and others that might like to hold back until say June. There are birds of all kinds of a feather.
In general, their views haven’t changed much since December, and at that meeting, the majority wanted to hike thrice this year. This throws up an interesting conundrum for timing when most seem to think the Fed prefers to change policy at the quarterly SEP/press conference meetings. How do you fit three into four? I mean, if we spread these three hikes over a year, then you hike at in-between meetings (May/July/Nov?). Maybe the odds of moving at these lesser dates is higher than normal.
What does “fairly soon” mean. It sounds like March or May…June would seem on the fringe of fairly soon. If the Fed doesn’t like the in-between dates, then it sounds like March. But if it’s only three this year, March sounds like a Fed stepping up the pace from last year, and getting a bit ahead of the three a year schedule. The broader tone of the minutes didn’t really suggest any additional urgency to hike since December; gradual remains the buzz word.
The change in government is generating heightened uncertainty. On balance it seems more likely to boost growth and inflation, but there are also downside risks. Some don’t want to get too caught up in government policy watching and appear more hawkish, some others would like more clarity before rushing to hike.
The balance of risks appears to have shifted somewhat more positive, albeit still wide, but several Fed members see further strength in the USD exchange rate as restraining the growth and inflation outlook.
The strength in the USD is mentioned four times in these minutes, illustrating that it was raised more often in this meeting than normal, by several members, as an issue that might moderate the need to hike.
Business optimism has been given a big boost by possible tax cuts and stripping back regulation. But the evidence of immediate impact on business investment is more cautious. This may indicate much depends on the Government to deliver on its tax policy.
The Fed is acutely watching the labor market. Several members are cognizant that it might already be on the verge of becoming too tight.
The USD is weaker in response to the minutes, perhaps because the increased mention of the USD exchange rate risks in the minutes resonates with the market. The strong USD was a factor that appeared to slow the expansion last year. The USD is historically strong and it has failed to build much moment over the last year even as US rates have risen, suggesting its multi-year rally is sucking wind.
The market may also be pushing back the scope and timing for the government to deliver on its tax/regulatory/infrastructure policy and instead is getting mired down in immigration and healthcare policy issues. Furthermore, the administration appears to want a weaker USD.
Below are my take-out quotes from the minutes, emphasis mine
Risks swing towards upside but remain wide
“In discussing the risks to the economic outlook, participants continued to view the possibility of more expansionary fiscal policy as having increased the upside risks to their economic forecasts, although some noted that several potential changes in government policies could pose downside risks.”
(Upside risks from possible fiscal expansion dominate, although there are some downside risks from other policies, such as protectionist and tougher immigration stance).
“In addition, several viewed the downside risks from weaker economic activity abroad as having diminished somewhat. “
(Less risk from abroad)
“But several indicated that they continued to be concerned about the downside risks to economic activity associated with the possibility of additional appreciation of the foreign exchange value of the dollar or financial vulnerabilities in some foreign economies, together with the proximity of the federal funds rate to the effective lower bound.”
(Several see a stronger dollar might weaken growth and inflation)
“Regarding the outlook for inflation, some participants continued to be concerned that faster-than-expected economic growth or a substantial undershooting of the longer-run normal unemployment rate posed upside risks to inflation.”
“However, several others continued to see downside risks to the inflation outlook, citing still-low measures of inflation compensation and inflation expectations or the possibility of further appreciation of the dollar.”
(Some hawkish, several others dovish, so about equal….strength of dollar mentioned a second time)
Housing caution
“A couple of participants commented that supply constraints might be holding back new homebuilding.
In addition, a few participants noted that prospects for residential investment would also depend on whether household formation picked up and how housing market activity responded to the recent rise in mortgage interest rates.”
(Couple hawkish, a few dovish, or at least expressing caution over higher mortgage rates)
Business surveys upbeat, action less so
“The available reports from District surveys of activity and revenues in the manufacturing and services industries were very positive.”
(Very positive surveys)
Moreover, a number of national surveys of sentiment among corporate executives and small business owners as well as information from participants’ District contacts indicated a high level of optimism about the economic outlook.”
(High level of small and large company optimism)
“Many participants indicated that their business contacts attributed the improvement in business sentiment to the expectation that firms would benefit from possible changes in federal spending, tax, and regulatory policies.”
(Optimism on possible tax cuts and stripping down regulation)
“A few participants indicated that some of their contacts had already increased their planned capital expenditures.”
“However, participants’ contacts in some Districts, while optimistic, intended to wait for more clarity about federal policy initiatives before adjusting their capital spending and hiring.”
“In addition, contacts in some industries remained concerned that their businesses might be adversely affected by some of the government policy changes being considered.”
(A few contacts report an immediate boost to capex, some not, some less. Surveys show optimism, contacts show mixed direct impact on capex. Fed may prefer to wait for activity data to confirm survey bounce)
“Activity in the energy sector continued to improve, with District contacts reporting an increase in capital spending, better access to credit, and a pickup in hiring.”
(Energy sector a positive influence)
Mixed labor market views
“Moreover, several participants’ business contacts reported shortages of workers in some occupations or the need for training programs to expand the supply of skilled workers.”
“Several other participants thought that some margins of labor underutilization remained, citing the still-high rate of prime-age workers outside the labor force, the elevated share of workers who were employed part-time for economic reasons, or the potential for further firming in labor force participation.”
“However, a couple of participants pointed out that the uncertainty attending estimates of longer-run trends in part-time employment and labor force participation made it difficult to assess the scope for additional increases in labor utilization.”
(Several hawkish, several dovish, couple uncertain?)
“Most participants still expected that if economic growth remained moderate, labor markets would continue to tighten gradually, with the unemployment rate running only modestly below their estimates of the longer-run normal rate.”
“However, several participants projected a more substantial undershooting.”
(Several see tight labor market – hawkish)
Mixed inflation views
“The available information on pricing from District business contacts varied, with a couple of participants reporting that firms were experiencing rising cost pressures from input costs or had been able to raise their prices, while a few other participants said that firms in their Districts were not experiencing price pressures or that the appreciation of the dollar was continuing to hold down import prices.”
“Some saw a risk that inflationary pressures might develop more rapidly than currently anticipated as resource utilization tightened, while several others thought that progress in achieving the Committee’s inflation objective might lag if further appreciation of the dollar continued to depress non-energy commodity prices or if inflation was slow to respond to tighter resource utilization.”
(Some see more inflation, several less…..strong dollar risk mentioned a third time)
Equities look frothy
A few participants commented that the recent increase in equity prices might in part reflect investors’ anticipation of a boost to earnings from a cut in corporate taxes or more expansionary fiscal policy, which might not materialize.
They also expressed concern that the low level of implied volatility in equity markets appeared inconsistent with the considerable uncertainty attending the outlook for such policy initiatives.
(A few think the equity market has built in too much optimism on Trump policy proposals)
Outlook same as Dec, emphasis on gradual
“Participants generally characterized their economic forecasts and their judgments about monetary policy as little changed since the December meeting.”
(Little change in eco or rates outlook since Dec)
“Most participants continued to judge that, while the outlook was subject to considerable uncertainty, a gradual pace of rate increases over time was likely to be appropriate to promote the Committee’s objectives of maximum employment and 2 percent inflation.”
(Gradual emphasis)
“Some participants viewed a gradual pace as likely to be warranted because inflation was still running below the Committee’s objective or because the proximity of the federal funds rate to the effective lower bound placed constraints on the ability of monetary policy to respond to adverse shocks to the aggregate demand for goods and services.”
(Gradual due to lower bound)
“In addition, it was noted that the downward pressure on longer-term interest rates exerted by the Federal Reserve’s asset holdings was expected to diminish in the years ahead in light of an anticipated gradual reduction in the size and duration of the Federal Reserve’s balance sheet.”
(Gradual next year because removing reinvestment will do some tightening)
“Finally, the view that gradual increases in the federal funds rate were likely to be appropriate also reflected the assessment that the neutral real rate–defined as the real interest rate that is neither expansionary nor contractionary when the economy is operating at or near its potential–was currently quite low and was likely to rise only slowly over time.”
(Gradual because only moderately accommodative)
Risks – higher government policy uncertainty
“These included upside risks such as appreciably more expansionary fiscal policy or a more rapid buildup of inflationary pressures,
(Up)
“as well as downside risks associated with a possible further appreciation of the dollar or financial vulnerabilities in some foreign economies, together with the proximity of the federal funds rate to the effective lower bound.”
(Down – dollar mentioned a fourth time)
“Moreover, most participants continued to see heightened uncertainty regarding the size, composition, and timing of possible changes to fiscal and other government policies, and about their net effects on the economy and inflation over the medium term, and they thought some time would likely be required for the outlook to become clearer.”
(Heightened uncertainty related to government policy)
“A couple of participants argued that such uncertainty should not deter the Committee from taking further steps in the near term to remove monetary policy accommodation, because fiscal and other policies were only some of the many factors that were likely to influence progress toward the Committee’s dual-mandate objectives and thus the appropriate course of monetary policy.”
“However, other participants cautioned against adjusting monetary policy in anticipation of policy proposals that might not be enacted or that, if enacted, might turn out to have different consequences for economic activity and inflation than currently anticipated.”
(A couple prepared to move ahead of government policy, since it’s not the only story, some prefer to wait for government policy clarity).
Rates outlook – fairly soon
“In discussing the outlook for monetary policy over the period ahead, many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the Committee’s maximum-employment and inflation objectives increased.
“A few participants noted that continuing to remove policy accommodation in a timely manner, potentially at an upcoming meeting, would allow the Committee greater flexibility in responding to subsequent changes in economic conditions.”
(Many want to raise fairly soon, a few want to at an upcoming meeting)
“Several judged that the risk of a sizable undershooting of the longer-run normal unemployment rate was high, particularly if economic growth was faster than currently expected. If that situation developed, the Committee might need to raise the federal funds rate more quickly than most participants currently anticipated to limit the buildup of inflationary pressures.”
“However, with inflation still short of the Committee’s objective and inflation expectations remaining low, a few others continued to see downside risks to inflation or anticipated only a gradual return of inflation to the 2 percent objective as the labor market strengthened further.”
(Several think rates may need to be raised faster than the market expects, a few think rates may be held lower for longer)
“A couple of participants expressed concern that the Committee’s communications about a gradual pace of policy firming might be misunderstood as a commitment to only one or two rate hikes per year and stressed the importance of communicating that policy will respond to the evolving economic outlook as appropriate to achieve the Committee’s objectives.”
(A couple think the Fed need to appear more responsive to data)
Reinvestment yet to be discussed
Participants also generally agreed that the Committee should begin discussions at upcoming meetings about the economic conditions that could warrant changes in the existing policy of reinvesting proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities, as well as how those changes would be implemented and communicated.
(Discussion on ending reinvestment in upcoming meetings)
Action plan
Many members continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly.
These members expressed the view that inflation was likely to rise toward 2 percent gradually, and that policymakers would likely have ample time to respond if signs of rising inflationary pressures did begin to emerge.
(Many see no urgency)
Other members indicated that if the labor market appeared to be tightening significantly more than anticipated or if inflation pressures appeared to be developing more rapidly than expected as resource utilization tightened, it might become necessary to adjust the Committee’s communications about the expected path of the federal funds rate.
(Others want to be more flexible)
One member noted that, even if incoming data on the economy and inflation were consistent with expectations, taking the next step in reducing policy accommodation relatively soon would give the Committee greater flexibility in calibrating policy to evolving economic conditions.
(One wants to hike soon)
The Committee also decided to maintain its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipated doing so until normalization of the level of the federal funds rate is well under way.
(Still waiting to well underway on ending re-investment)
