Maybe March, More Likely May

The incoming data and public remarks by participants prior to the release of the minutes already suggested the odds of a March hike had increased. We read the minutes as supporting that assessment, and we have consequently boosted the probability of a March hike from 33% to 40%. They are getting closer—and  more confident that they are closer—to the next move. But with the data in, they are probably not there just yet. If events evolve as we expect, the minutes suggest to us that the FOMC will cross the action threshold by May; we put the odds at 55%. And if not then, we see a high probability of a move in June— around 80%. Looking ahead, the two most obvious events that would alter our assessment of the likelihood of a hike in March or later are speeches by Fischer and Yellen on March 3 and the employment report the following Friday. 

FOMC participants and the staff noted that their outlooks for the economy and inflation were little changed from December. The labor market continued to strengthen, the economy was expanding at a moderate pace, and inflation appeared to move closer to its 2% objective. In other words, their earlier expectations for the outlook looked firmly on track. And they appeared a bit more confident in offering this assessment.  Notably, participants expressed more optimism about the business sector, specifically prospects for investment spending. and they pointed to diminished downside risks from abroad. 

∙ The outlook for the business sector “improved further” between the December and January meetings,  an observation that also caught our attention in the FOMC statement. 

∙ Participants also noted “widespread gains” in nondefense capital goods orders in recent months. ∙ “Many” participants said that business contacts cited the expectation that changes in tax, regulatory,  and spending policy (that is, Trump and the Republicans) would benefit firms as the reason for the improved business sentiment. 

∙ Later in the minutes, a few participants noted that, while this improved sentiment has been reflected in  higher equity prices, the expected policy changes underpinning that improved sentiment might not materialize. 

We saw a slight dissonance between the message from the broader group of FOMC participants and the portion of the minutes reporting the views of the narrower group of voting members concerning the risks of substantially undershooting the NAIRU and overshooting the 2% inflation objective. 

∙ “Many” Committee members saw “only a modest risk” of such a scenario and thought that policymakers would, in any case, have “ample time to respond” if signs of such an outcome did begin to emerge. 

∙ Moreover, only one member noted that, if the outlook evolved as expected, taking the next step in raising rates relatively soon would give the Committee more flexibility in calibrating policy to evolving economic circumstances. 

∙ That suggested that the increased flexibility offered by a March hike to raise rates four times this year was not an important consideration for most FOMC members. 

∙ On the other hand, “many” FOMC participants expressed the view that “it might be appropriate to raise  the fund’s rate again fairly soon if incoming information on the labor market and inflation was inline 

with or stronger than their current expectations or if the risk of oversharing eh Committee’s maximum  employment and inflation objectives increased.” 

∙ Perhaps this dissonance perhaps reflects a composition of voting FOMC members that are now more dovish than last year’s, and more dovish than the wider group of participants. (See our analysis.) While the “fairly soon” wording was an obvious signal for an upcoming rate hike, we would caution that the mention of “ample time to respond” in the members’ discussion is a significant counterpoint that suggests there was no great urgency among the voting members. 

Participants agreed that fan charts for their macro projections would be included in the March SEP. ∙ Recall that the fan chart originally proposed by the subcommittee in January 2016 would be  “constructed largely from information on historical errors from government and private-sector forecasts  that are already provided in the SEP.” (The fan charts to be shown in March will be based on a revised  proposal.) 

∙ There was no mention of any changes in the dot plot, so the uncertainty associated with the macro projections will not be reflected in a band of uncertainty around the median rate projections. 

There was an interesting discussion about a possible need to change the Committee’s communication regarding the anticipated path of the policy rate if economic conditions evolved differently than expected or if the outlook changed. 

∙ Participants pointed to the upside risks, such as an “appreciably more expansionary” fiscal policy and “a  more rapid buildup of inflationary pressures.” 

∙ Under these circumstances, we would expect the key change in communications would be to move away from an emphasis on a “gradual” path of rate hikes. 

∙ But participants also talked about downside risks associated with the possible further appreciation of the dollar and external risks. Such downside risk took on further importance because of the proximity to the zero lower bound, a recurring theme in the risk management discussion and one that occurred a couple of times in the minutes. 

Participants also agreed that they should begin discussions at upcoming meetings about the end of the reinvestment program. 

∙ In particular, they would discuss “the economic conditions that would warrant changes” in that program. ∙ The timing has been linked in recent statements to the normalization of rates being “well underway,”  so this appears to mark a shift from a threshold in terms of the level of the fund’s rate to one tied directly to economic conditions.

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