More Confident About Inflation,

But Little Alarm About Overheating 

The period leading up to the May FOMC meeting has been much less eventful than the period before the  March meeting, and the themes in FOMC participants’ remarks have remained intact. Policymakers remained confident in the outlook, especially with fiscal stimulus set to begin boosting growth. There was more optimism about the inflation outlook, which some participants linked to their support for a slightly faster pace of rate hikes. Their comments on trade were largely the same. Many acknowledged that there was legitimate concern about existing trade practices, but they hoped such concerns would be addressed without escalation into a trade war, which would likely be quite damaging. Trade remained a downside risk to the forecast,  though they acknowledged that uncertainty about trade policy could itself be detrimental to economic activity.  The shape of the yield curve remained a topic of discussion, with some participants continuing to voice discomfort about the prospect of an inverted curve. 

FOMC participants continued to have great confidence in the outlook for growth. Trade policy remained a  downside risk to growth, and there was agreement that a trade war scenario would be very harmful to economic activity. President Bullard (4/4) saw the risks as having increased: “In recent days, we are talking about more generalized tariffs between us and China. That is a more significant development” than the narrower tariffs originally announced. He expected “a bumpy ride for all of us as these negotiations proceed.”  President Bostic (4/5) said he was taking a wait-and-see approach with respect to trade outcomes, an approach other participants appear to be taking as well. President Williams (4/6) said, “So far, the kind of  things that have been happening about specific actions — they don’t add up to a huge effect on the economy.”  

Policymakers clearly had more confidence in meeting the price stability mandate. Many expected a slight overshoot of the two percent objective in coming years and saw that as a good outcome. President Harker  (3/29) said, “It’s more the firming of inflation that has moved me from two [hikes] to three.” He expected inflation to reach two percent this year and move slightly above two percent thereafter. President Bostic  (3/28) said, “the inflation measures we are looking at are trending toward 2 percent. The evidence is more there than some may understand. Let’s get back to neutral.” Still, he advocated a gradual pace, including three hikes this year, that would bring the funds rate to neutral “at least a year away from now and possibly more” (3/23). He suggested that he sees neutral as between 2¼ percent and 2¾ percent, which would place his estimate to the lower side of participants’ estimates. Like Presidents Harker and Bostic, President Kaplan also projected three hikes this year. 

President Mester (3/26) sounded somewhat cautious about the inflation outlook, at least considering we’ve seen her to the hawkish side. She said, “We want to give inflation time to move back to goal.” She continued to point to the dots, as did President Dudley (4/16). He indicated that the market is correct in its apparent view that a pace faster than four hikes per year is very unlikely. He suggested that inflation above its objective  “by an appreciable margin” could warrant a faster pace, however. His comments (4/18) perhaps took a  somewhat more dovish tone than earlier in the year: “the case for tightening policy more aggressively does  not seem compelling.” He added that this view “is reinforced by the fact that we do not know with much  precision how low the unemployment rate can go without prompting a significant rise in inflation.” He also  said that his estimate of the neutral fund’s rate is probably around 3 percent, explaining, “Although that is  

higher than the estimates from some models, I have nudged up my estimate because financial conditions are  still easy and fiscal policy will likely be quite stimulative in 2018 and 2019.”  

President Williams (4/6), who is soon to be president of the New York Fed, continued to convey a somewhat greater sense of urgency than some of his colleagues about the need to prevent overheating. He reiterated his support for “three or four” hikes in 2018, but his comment that “strong financial conditions, better-than-expected global growth, and fiscal stimulus of lower taxes and higher spending have all created tailwinds”  suggests he favors four. He expected inflation to “slightly exceed our longer-run 2 percent goal for the next  few years.” President Rosengren (4/13) said he favored four hikes this year, saying that tighter policy was necessary to limit overheating and avoid a recession.  

There was a little movement even among the doves, as they acknowledged the strong outlook. President  Kashkari (3/23), who has long argued against rate hikes, said he approved of the decision to raise rates in  March, though he maintained that, “Personally, I think we have a ways to go before we achieved our dual  mandate objectives.” He later explained that he had “brought forward some [projected rate hikes] as a result of the [fiscal] packages” (4/12). Both Presidents Bullard (4/4) and Kashkari (4/3) saw the stance of monetary  policy as already close to neutral, in contrast to others, such as President Dudley (4/18), who said, “there is  still some distance to go before monetary policy actually gets tight.” 

Governor Brainard (4/3) reiterated her concern that “a booming economy can lead to a relaxation in lending standards and an attendant increase in risky debt levels,” a sentiment that was mentioned in the minutes of the March FOMC meeting. She specifically addressed the risks presented by “pro-cyclical fiscal stimulus at a  time when resource constraints are tightening and growth is above trend.” Periods of very low unemployment  have “tended to see a risk of accelerating inflation in earlier decades or a risk of financial imbalances in more  recent decades.” President Mester (3/26) said, “I don’t feel that there’s a lot of excess financial imbalances out there,” but noted that continuing to remove accommodation would limit the prospect of such imbalances forming. 

Policymakers continued to comment on the shape of the yield curve, as it flattened at points during the intermeeting period. Policymakers expressed varying degrees of discomfort with the idea of an inverted yield curve. Even among those who expressed the most discomfort, there was general confidence that longer-term rates would rise, avoiding such a situation. For example, President Harker (3/29) expected increased issuance and a shrinking Fed balance sheet to contribute to a steepening curve. However, he said that “If  that doesn’t occur in a way that I anticipate, then I’d be willing to slow the pace of increases.” President  Kaplan (4/9) seemed to share a similar view, saying, “I’m not going to say blindly we should be raising rates  if the curve keeps flattening.” He said, “The flat yield curve tells me the bond market sees sluggish economic  growth in the medium term and I for one do not want to be in the position of raising the fed funds rate and  creating an inverted yield curve.” President Bullard (4/13) remained much more alarmist than his colleagues,  saying that continuing to tighten would cause the curve to invert later in the year, which would signal a  recession. President Evans (4/20) had previously expressed concern about the shape of the yield curve, but  he suggested that “The yield curve is not nearly as much of a concern as I might have pointed to a couple of months ago.” He saw increased U.S. issuance steepening the curve. 

President Williams’ (4/17) remarks on the shape of the yield curve probably drew the most attention, his concerns about inversions perhaps being seen as a dovish signal. He said that an inverted yield curve “is a  powerful signal of recessions” and that they have occurred “when the Fed is in a tightening cycle, and markets  lose confidence in the economic outlook.” However, he also said that “The flattening of the yield curve that  we’ve seen is so far a normal part of the process, as the Fed is raising interest rates, long rates have gone  up somewhat — but it’s totally normal that the yield curve gets flatter.” He later elaborated on those remarks,  emphasizing that he was not concerned about a yield curve inversion because he expected longer-term rates to rise. In any case, we didn’t see his remarks as much different from comments he’d made previously, in late 2017.

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