We read the minutes of the October-November FOMC meeting as somewhat dovish. Despite widespread optimism on the outlook for growth and continued improvement in the labor market, the FOMC seemed to be more concerned about low inflation and appeared to be losing patience with the story that the weakness will prove transitory and that expectations are and will remain well-anchored. As a result, the discussion indicated that the Committee is less confident than we had expected in the timing and pace of policy tightening after December. However, a December rate hike is a done deal, given that markets have nearly fully priced in a hike and there are relatively little significant data still to come that could derail those plans. Given our forecast, we’re still comfortable with three hikes in 2018. But both the apparent greater concern of the FOMC about downside risks to inflation and relatively subdued concern expressed about an overheating economy perhaps make us see less risk of four hikes.
The minutes exuded confidence in the outlook for both growth and the labor market. ▪ “Participants saw the incoming information on spending and the labor market as consistent with continued above-trend economic growth and a further strengthening in labor market conditions.” ▪ All disruptions from the recent hurricanes were seen as temporary.
▪ “Many participants judged that the economy was operating at or above full employment and anticipated that the labor market would tighten somewhat further in the near term, as GDP was expected to grow at a pace exceeding that of potential output.”
▪ The discussion of growth and the labor market was clearly optimistic. However, the outlook wasn’t described as having been meaningfully upgraded, and there was no sense of any greater concern about getting behind the curve with respect to tightening policy.
There was extensive discussion of inflation, and overall we were somewhat surprised by the level of unease expressed about downside risks to inflation.
▪ In particular, “Many participants observed, however, that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors but also the influence of developments that could prove more persistent.”
▪ Of that group (“many”), “a number” we’re concerned that a decline in inflation expectations would make it more difficult to achieve the inflation objective, especially given the low level of r-star and the flatness of the Phillips curve.
▪ “Some others” were more concerned about upside risks. Reasons included that “the economy had reached full employment and the labor market was projected to tighten further,” financial conditions remained accommodative, and that there could be potential risks to financial stability.
▪ We should note, however, that subsequent to this meeting there was a firmer inflation reading (October CPI) that may have marginally reduced policymakers’ concerns about persistently low inflation.
In addition, the discussion about views on a hike in the near term (meaning December) noted that “several” participants wanted to see evidence of inflation firming before committing to a further rate increase. But we still think that group is in the minority and that December’s a done deal.
▪ “Many” participants thought a December hike would be appropriate “if incoming information left the medium-term outlook broadly unchanged.”
▪ However, “several,” thought the December hike decision would “depend importantly on whether the upcoming economic data boosted their confidence” that inflation was headed to 2 percent. ▪ Additionally, “a few other” participants thought a hike “should be deferred” until the data confirmed inflation was “clearly” on a path to 2 percent. “A few” participants saw “further [rate hikes] while inflation remained persistently below 2 percent” potentially threatening inflation expectations and the credibility of the inflation objective. This indicated a bit more hesitance on the part of some to hike than we had expected.
Bottom line: We still think a December hike is a done deal. Indeed, the FOMC will hike because markets have interpreted them as indicating with near-certainty that they will move in December. But the unease about inflation makes clear that a hike in March will likely be conditional on the inflation data boosting confidence that it is headed to 2%.