Greater Likelihood of “Further” Gradual Increases in Rates

The minutes of the January FOMC meeting did not affect our views on the likely path of the fund’s rate—we still anticipate four rate hikes in 2018. The tone of the minutes did, however, suggest to us a marginally greater likelihood of a hawkish shift in the projections and messaging at the March meeting. That said, we still expect the median dot to remain at three hikes in 2018 until at least June. 

The message from the minutes was overwhelmingly positive with respect to output growth, the labor market,  inflation, and financial conditions. Of course, a lot has happened since the January meeting that is not reflected in these minutes; more on these more recent developments below.  

▪ The growth outlook was unambiguously stronger: “A number of participants indicated that they had  marked up their forecasts for economic growth in the near term relative to those made for the December  meeting in light of the strength of recent data on economic activity in the United States and abroad,  continued accommodative financial conditions, and information suggesting that the effects of recently  enacted tax changes—while still uncertain—might be somewhat larger in the near term than previously  thought.” 

▪ This theme was reflected throughout the minutes. For example, “most members viewed the recent data  bearing on real economic activity as suggesting a modestly stronger near-term outlook than they had  anticipated at their meeting in December.” 

▪ Participants were clearly satisfied with the incoming data and outlook for inflation, even without having  in hand the strong January data: “many participants noted that inflation data in recent months had  generally pointed to a gradual rise in inflation.” This had clearly increased their confidence in a return of inflation to their 2% objective. 

▪ The only area of ongoing concern was wage developments: “While some participants heard more reports  of wage pressures from their business contacts over the intermeeting period, participants generally noted  few signs of a broad-based pickup in wage growth in available data.”  

With respect to monetary policy, the official message was that the stronger outlook for growth, associated in part with a larger-than-expected tax cut, did not necessarily increase the likelihood of a faster pace of rate hike. Rather, it only increased the likelihood of a gradual pace of hikes. The minutes did not note a single voice raised in support of a faster pace of hikes. 

▪ However, reading between the lines, we see the discussion as indicating that, in fact, participants and Committee members did see a greater likelihood of a faster pace of rate hikes. How could it be otherwise? ▪ The minutes provided us with a tortured explanation of the FOMC’s decision to cite “further” gradual  funds rate increases in the statement: They made this change because “the strengthening in the near term economic outlook increased the likelihood that a gradual upward trajectory of the federal funds rate  would be appropriate.” Taken literally, this seems to say only that the risk of a pace that is slower than  “gradual” has diminished. 

▪ This same sort of language was used elsewhere in the minutes: “A majority of participants noted that a  stronger outlook for economic growth raised the likelihood that further gradual policy firming would be  appropriate.” 

▪ What the minutes didn’t explicitly say is that participants (or members) see a faster pace of rate hikes as likely to be appropriate, relative to December. 

▪ However, what discussion there was of the fund’s rate path, as well as the stronger outlook for growth and increased confidence that inflation was headed to 2%, indicated to us that participants’ fund’s rate projections were are already shifting higher in late January. 

As we noted above, several significant developments followed the January FOMC meeting and were not reflected in these minutes, and all, except for the decline in equity prices, push in a hawkish direction. ▪ The growth outlook will certainly have gotten stronger since the January meeting because of the  

massive spending bill recently enacted. Equity prices are only somewhat lower, on the net, as a sharp decline was followed by a partial reversal—a development that will only marginally damp the outlook in comparison. 

▪ The recent inflation data were quite strong and will only increase participants’ confidence that inflation will firm further. 

▪ Finally, the recent wage data, including the ECI and average hourly earnings, have been firmer. These would have given at least some participants more confidence that a broader firming in wages would become apparent in the data. 

The minutes also reported that the FOMC and staff discussed once again models of inflation. That discussion did not reveal any new insights into the inflation process and did reveal the FOMC’s (and the profession’s)  loose understanding of the inflation process. 

▪ One message was that there are lots of problems with estimating and using Phillips curve models, but  they’re still the main game in town: “Almost all participants who commented agreed that a Phillips curve type of inflation framework remained useful as one of their tools for understanding inflation dynamics and  informing their decisions on monetary policy.” 

▪ Another message was that there are lots of problems with assessing inflation expectations, but  “Participants generally agreed that inflation expectations played a fundamental role in understanding and  forecasting inflation, with stable inflation expectations providing an important anchor for the rate of  inflation over the longer run.” 

▪ As part of this inflation discussion, and particularly the discussion of the possibility of longer-run inflation  expectations slipping lower, “a number of participants noted the importance of continuing to emphasize”  that the 2 percent objective is “symmetric.” ▪ There was also some mention of the discussion of adjustments to the monetary policy framework, but nothing  suggesting any consensus for or momentum toward reform: “A couple of participants suggested that the  Committee might consider expressing its objective as a range rather than a point estimate,” and “A few  other participants suggested that the FOMC could begin to examine whether adopting a monetary policy  framework in which the Committee would strive to make up for past deviations of inflation from target  might address the challenge of achieving and maintaining inflation expectations consistent with the  Committee’s inflation objective.”

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