We saw Yellen’s speech last week as consistent with our (close) call that the FOMC will raise rates in December (See Message from Yellen: Steady Hand, But Alert to Inflation Developments). Her remarks indicated that there is a solid consensus on the FOMC that the recent slowing in core PCE inflation is due principally to transitory forces, in which case underlying inflation rate is not as low as recent core inflation readings might indicate. However, she discussed many sources of uncertainty surrounding the inflation outlook, and on balance her remarks suggested that she sees these factors as tilting the risks to the inflation outlook to the downside, though she did not explicitly say so.
Policymakers’ Comments
As for other policymakers’ remarks, there were more remarks from dovish than from hawkish participants, which made the general tenor of comments more dovish than the likely consensus of the FOMC. The doves remained skeptical of inflation’s impending return to its two percent objective, suggesting they want to see more data to resolve their concerns; otherwise, they likely will not support a December hike. Evans pointed to the inflation shortfall as a phenomenon that is possibly structural: “I’m a little nervous that some of the recent weakness might be a little more structural. It might be some things that we don’t fully understand. It could be cleared away in a couple of months of data. I think it probably takes more than a couple of months of data.” Kashkari preferred no further rate hikes until 12-month core PCE inflation reaches two percent, as long as the unemployment rate does not drop suddenly or inflation expectations increase more than expected. Bullard seemed to be skeptical of the passthrough from a stronger labor market to higher inflation: “Low unemployment readings are probably not an indicator of meaningfully higher inflation over the forecast horizon…Even if the U.S. unemployment rate declines substantially further, the effects on U.S. inflation are likely to be small.” He cited the market’s lack of belief in the median rate projections as further evidence of the lack of confidence in the Phillips Curve framework.
Harker is in a wait-and-see posture, though tentatively expecting to support a December hike: “I still penciled in an increase in December and three increases for ’18, assuming that inflation comes back…But I do emphasize the word ‘pencil-in’ because we just have to see how things evolve.” He added that “inflation is the one area that does give us a little bit of pause.” Harker also revealed what his dots reflected in terms of the effect of balance sheet normalization on the appropriate path of the funds rate His funds rate views already assumed balance sheet tightening would be the equivalent of one rate hike over the next several years.
On the other hand, Bostic appeared ready to support a December hike, based on his interpretation of the incoming data with respect to wage and price pressures. He was “feeling pretty comfortable about the idea that we will be looking to move rates come December,” citing “far more pressure from a wage perspective and a pricing perspective.” Rosengren shared the same view, warning of a risk of overheating: “[The data] suggest to me an economy that risks pushing past what is sustainable, raising the probability of higher asset prices, or inflation well above the Federal Reserve’s 2 percent target.” He concluded that “policy makers should not overreact to low current inflation readings that are widely expected to be temporary.” Policymakers were also concerned specifically about inflation expectations. Kashkari observed that “people’s expectations for inflation have been drifting lower,” while Evans thought that “inflation expectations are lower than consistent with our 2 percent objective.” Bullard concurred, noting that “inflation expectations are uncomfortably low at this point” and market expectations were “below what you would like to be consistent with a 2% inflation.”
On net, financial conditions did not appear to be a central factor in policymakers’ views of appropriate policy. Evans argued that they are currently not a concern: “I look at the financial conditions and I see that they are supportive of growth. That’s a good thing. I don’t see them as being some critical risk at the moment for the expansion or anything like that.” Bostic said, “I actually don’t think that our policies are too easy in the sense of really facilitating some sort of asset bubble.” However, Bullard warned that “equity valuations may be stretched.” Rosengren saw regulatory policy as the first line of defense against financial imbalances.
Williams lowered his estimate of the (nominal ) neutral rate to 2½%, below the median of FOMC participants. He said, “That is low…And, if historically the Fed usually cuts interest rates by 4–5 percentage points during typical recessions, that is no longer possible if you are starting at 2.5–3.0%.” He suggested that a coordinated increase in central banks’ inflation objectives from two percent might be called for, on the basis that real productivity and the neutral rate are declining. Harker said that he was “not opposed” to an increase in the inflation objective.