Consistent With Our Call

The minutes of the December 2017 FOMC meeting contained no significant revelations, but they did shed some light on current Committee thinking. The FOMC has gained confidence in the outlook for economic activity owing to the stronger tone of the incoming data and an impending sizeable tax cut. FOMC participants also acknowledged that recent readings on core inflation have been somewhat firmer. They seemed to have more confidence in the story that the slowdown in core inflation this year was largely due to transitory factors,  though that debate has not been settled. All told, we see these minutes as consistent with our call for four rate hikes in 2018 and also with our call for a meaningful overshoot of the neutral fund’s rate in 2020. 

FOMC participants saw the outlook for activity as having improved somewhat, with the tax cut (nearing passage at the time of the meeting) contributing partly to their upwardly revised projections. ▪ In particular, “participants saw the outlook for economic activity and the labor market as having remained  strong or having strengthened since their previous meeting.” 

▪ FOMC participants saw the tax legislation is likely to provide “a modest boost” to the outlook, and it was cited in particular as likely to boost consumer spending (“many” expected “some boost”) and capital spending (“many” expected “a modest boost”). 

▪ It was repeatedly noted that the effects of the tax legislation were highly uncertain. ▪ “A few participants noted that expectations of tax reform may have already raised consumer spending  somewhat to the extent that those expectations had spurred increases in asset valuations and household  net worth.” 

The SEP provided some further detail on how the tax legislation had affected participants’ outlooks. ▪ It was noted, “Most participants pointed to changes in tax policy as likely to provide some boost to real  GDP growth over the forecast period; in September, fewer than half of the participants incorporated  prospective tax policy changes in their projections.” 

▪ In addition, “Several participants indicated that they had marked up their estimates of the magnitude of  tax cuts, relative to their assumptions in September.” 

The possibility that tax reform might raise potential GDP received a couple of mentions.  ▪ The higher capital spending that “many” expected would increase the capital stock and “could contribute  to positive supply-side effects, including an expansion of potential output over the next few years.” ▪ Another channel mentioned was the effect of lower personal taxes on labor supply: “A few participants  noted that a reduction in personal tax rates could potentially increase labor supply,” though it was noted  that “the magnitude of such effects was quite uncertain.” 

▪ The FOMC appeared to be signaling that it is aware of possible beneficial supply-side effects, even while their projections show that the consensus is that this tax legislation is primarily demand-side stimulus. 

The tone of the inflation discussion revealed more confidence than in November that the low inflation of 2017  would likely prove transitory. 

▪ Participants generally agreed that recent data had been firmer: They noted that monthly inflation had  “edged up” and a “couple” saw the 12-month measure “stabilizing,” compared with multiple references to downside surprises in the minutes of the November meeting. 

▪ “Many” continued to see the softness as reflecting transitory factors, which participants expected will wane, thus easing downward pressure on inflation. 

▪ Compared with November, less discussion appeared to be devoted to a struggle to grasp the underlying causes of softer inflation. Previously, “several” pointed to “diminished responsiveness” of inflation to slack, uncertainty about the degree of slack, and lags to responsiveness as possible reasons. 

▪ The SEP further revealed that the distribution of participants’ assessment of risks around their inflation projections shifted from slightly to the downside to broadly balanced. 

The labor market was seen as strong and likely to continue to tighten. 

▪ For several years now, the minutes have included substantial discussion about the debate over the remaining slack in the labor market, but that debate has largely receded. 

▪ There seemed to be general agreement that the labor market was tight, with reports about the difficulty of finding qualified workers, but there was relatively little concern expressed that the labor market has already overheated. The discussion of wage growth was quite bland: “the pace of wage increases had  generally been modest and in line with inflation and productivity growth.” 

▪ “A few participants judged that the tightness in labor markets was likely to translate into an acceleration  in wages; however, “another” observed that the absence of broad-based upward wage pressures  suggested that there might be scope for further improvement in labor market conditions.” This suggests that only one participant was openly arguing for the possibility that more slack remains in the labor market. 

▪ These minutes did nothing to explain what we’d seen as a disconnect between the fairly substantial upward revisions to projected real GDP growth and relatively modest downward revisions to the path of the unemployment rate. 

While the recent flattening of the yield curve caught the Committee’s attention, it did not seem likely to imminently affect the course of monetary policy. 

▪ The minutes cited a wide range of factors contributing to flattening, such as recently higher short-term rates, lower term premiums, Treasury issuance supply effects, changes in r-star expectations, and declines in inflation expectations. 

▪ Participants showed little alarm over yield-curve developments; they “generally agreed” the current  flatness was “not unusual by historical standards.” 

▪ While “a couple” were worried that a future inversion of the yield curve “could portend” a recession, “a  couple” others saw inversion as more of a technical consequence of the FOMC’s funds rate policy and did not see inversion as signaling a recession.  

The discussion of the FOMC’s funds rate projections supported our baseline projection that there will be a  funds rate overshoot by 2020. 

▪ “Nearly all” participants projected an overshoot of the funds rate above its neutral “at some point” through  2020. 

▪ The distribution of dots for year-end 2020 revealed an obvious upward shift and a stronger consensus for an overshoot. ▪ Broadly speaking, there was little in the way of discussion of what would drive FOMC participants’  upcoming fund’s rate decisions. They recited their catechism: Faster growth and greater inflation pressures could lead to a steeper path for the fund’s rate, while a failure of inflation move back to the 2 percent objective could lead to a flatter path. Gee, not much news there.

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