Since the May FOMC meeting, FOMC participants were confronted with data surprises with conflicting implications for monetary policy: softer-than-anticipated inflation data, a slowdown in payroll gains, and a further decline in the unemployment rate. They were willing to look through the inflation data, attributing the softness partly to transitory factors. There was certainly no indication that the inflation data, or anything else, would prevent the FOMC from raising rates at the June meeting. Indeed, while FOMC participants didn’t explicitly advocate a June hike, not pushing back against market expectations of one was tacit confirmation that the FOMC would raise rates this week. While they were willing to look through the data for now, and the consensus still appeared to be that three hikes would be appropriate this year, there were hints that further adverse inflation readings might divide an FOMC that has been remarkably united this year. The discussion on balance sheet policy continued, with Governor Powell’s remarks especially notable, as he discussed what the size of the Fed’s holdings might be under various scenarios, provided insight on how FOMC participants may be viewing the effects on financial conditions of a normalizing balance sheet and suggested he would support maintaining the current operational regime of abundant reserves.
Governor Powell was one of the last FOMC participants to speak before the blackout period ahead of the June FOMC meeting, and he displayed little concern about the recent inflation readings (6/1). He said the rise in 12-month core PCE inflation “appears to have paused” but noted that “some of the recent weakness can be explained by transitory factors” and “there are good reasons to expect that inflation will resume its gradual rise.” Other FOMC participants likewise showed little concern about the recent inflation data. President Harker said, “I think the concern over a couple of months of less-than-perfect inflation data is unwarranted” (6/2). President Kaplan argued that “for a number of I think idiosyncratic reasons, inflation dipped,” and said that, “while inflation has been slow and uneven, I don’t think we have a deteriorating trend.” President Evans, one of the policymakers who has shown more concern about the persistence of below-2% inflation, had no problem looking through the data for now: “My view has been I’m going to sort of look through that until I get a better reading as to whether or not its altered its trajectory…or if it’s just sort of a little pause.” Even Governor Brainard was willing to look through the recent inflation data, but she warned that “If the soft inflation data persist, that would be concerning and, ultimately, could lead me to reassess the appropriate path of policy” (5/30).
Policymakers broadly agreed that the labor market is very close to full employment—if it’s not already there. President Harker said “we’re essentially at normal now” (6/2). Policymakers dismissed any concerns over a recent slowdown in payroll gains, noting that the pace remains very robust. Indeed, speaking after the strong employment report for April, before the weaker May data were released, President Williams said that “we do need to see the pace of job growth get to more sustainable levels” and that “our estimates tend to tell you there’s not only no slack today, but actually the economy is operating above potential.” President Harker noted that “in the very near future, we’re not going to need to create jobs at the intense pace we’ve been experiencing over the past few years” (6/2). He noted that the recent pace of gains was well above the 100K per month pace he suggested was needed to keep up with population growth.
Governor Powell noted that “the global picture has brightened” and domestic risks “seem both moderate and balanced,” comments echoed by many of his colleagues (6/2). He expected the economy to continue to grow at “about 2 percent.” Consistent with their willingness to look through the recent inflation data and believe that the outlook for growth remained favorable, policymakers continued to point to a total of three hikes this year as a reasonable expectation (Kaplan, 5/9; Williams, 5/30; Powell, 6/1; Harker, 6/2). President Williams emphasized that a total of four remained a possibility if the data were strong. President Evans said, “In this environment, I think that I said I would be OK with two [more hikes this year]. I could be OK with one as well if there are more uncertainties about the inflation outlook” (5/12). President Rosengren continued to see a somewhat faster tightening as appropriate, saying he still saw four hikes this year as “reasonable” (5/10). Presidents Mester and George made it clear that they remain among the more hawkish FOMC participants with respect to the pace of rate hikes. President Bullard remained a dovish outlier, saying he was open to one more rate hike this year (5/5).
There was widespread support among FOMC participants for beginning to reduce the size of the Fed’s balance sheet later this year. They did not see the beginning of balance sheet normalization as likely to be disruptive to markets. Some of the most significant comments were those of Governor Powell (6/1) [link to our commentary]. He reviewed the FOMC’s existing guidance regarding balance sheet policy, including the discussion in the May minutes of a plan to phase out reinvestment by introducing caps, which would gradually be raised, on the dollar amount of securities allowed to run off each month. We saw it as significant that he described one of the FOMC’s principles as “the balance sheet should be no larger than it needs to be to allow the Committee to conduct monetary policy under its chosen framework” (our emphasis). He suggested that he would favor remaining in the current “floor” system with abundant reserves rather than returning to a pre
crisis “corridor” system: A floor system “is simple to operate and has provided good control over the federal funds rate,” whereas a corridor system “may be less robust over time.” He also acknowledged that the balance sheet is likely to remain much larger than it was before the financial crisis, even if the FOMC chooses to return to a system with scarce reserves: “It’s hard for me to see the balance sheet getting lower than $2.5 trillion, $2.5 to $3 trillion.”
Governor Powell also delved into the issue of how balance sheet normalization might tighten financial conditions by putting upward pressure on long-term rates. He described model-based estimates of the effects as “generally modest.” However, he acknowledged that “of course if there’s a bigger effect than I would expect, then that would be taken into consideration in setting rates.” He also talked about the potential market reaction to the change in reinvestment policy. He noted that there was a “pretty small” market reaction to the news that the FOMC expected to begin to allow runoff this year, which gave him “some confidence there may not be a big market reaction.” However, he noted that it is difficult to predict how the market might react.