More Interesting than Informative

While not uninformative, the minutes to the June FOMC meeting provided little additional clarity about near-term policy prospects. On the phasing out of reinvestment, there was less discussion pointing to a September announcement than we had expected, though we still read the minutes as consistent with our expectation of a September announcement. Most participants viewed the recent slowing of core inflation as reflecting idiosyncratic factors that would have only a temporary effect on inflation. Thus, the low readings on core inflation have not materially affected the view of most participants about the path of rates. But for some, the recent inflation data renewed and reinforced concerns about progress toward the 2% objective. While the focus of the meeting was on balance sheet plans rather than the prospects for a third rate hike, there was an interesting discussion of the implications of balance sheet normalization for the path of rate hikes. Conditional on there being confirmation of their view (and ours as well) that the low readings on inflation will prove transitory, we still anticipate a third rate hike this year to occur in December. 

The discussion of the timing of the announcement of the phasing out of reinvestment did not provide as strong a lean toward a September timing as we expected, but it did not weigh against it either. ▪ “Several preferred to announce a start to the process within a couple of months.” That suggested they might favor an announcement before the September meeting. 

▪ But “some” preferred to delay the announcement until later in the year to allow more time to assess the outlook for economic activity and inflation. We see that discussion as consistent with a September announcement, while not ruling out a deferral until November or December should the inflation data remain soft. 

There was, as expected, a discussion of the source of and implications for monetary policy of the more-muted inflation in the last few months. 

▪ Participants agreed that the lower-than-expected readings on core inflation partly owed to factors that appeared to be temporary. 

▪ Most viewed softness as “largely reflecting idiosyncratic factors” and “expected these developments to  have little bearing on inflation over the medium term.” 

▪ However, “several”—more than the “few” at the May meeting—expressed concern that the progress toward the inflation objective might have slowed and that recent softness could persist. ▪ On balance, the recent inflation data had not yet affected the view of the Committee about the appropriateness of another rate hike this year. 

▪ Interestingly, a couple of other participants viewed the sharper-than-expected decline in the unemployment rate as potentially suggesting more upside risk to inflation in the medium term! 

There has been a lot of discussion in participants’ public comments of easier financial conditions, including the accompanying potential for overvaluation in some asset markets and for broader financial instability.  ▪ It was noted that, according to some measures, financial conditions had eased over the last six months despite multiple rate hikes and market expectations of further hikes. 

▪ The easing of financial conditions was seen by a few to have strengthened the case for the June hike.  

▪ Participants discussed a variety of explanations for this development. A few expressed concern that subdued market volatility, combined with a low equity premium, could lead to a buildup of risks to financial stability. This group would likely prefer a faster pace of rate hikes, but we see only a minority on the  Committee advocating this more aggressive policy stance. 

While there has been some discussion of the effect of balance sheet normalization on the path of rate hikes in speeches, this is the first time that such a comprehensive discussion of what we have called the  “substitution” effect has appeared in the minutes.  

▪ Several saw the commencement of balance sheet normalization as “one basis for believing that…the  target range for the federal funds rate would follow a less steep path than it otherwise would.”  ▪ On the other hand, some others did not see balance sheet normalization as a factor “likely to figure heavily in decisions” about the fund’s rate.  

▪ A few of these participants judged that the degree of additional policy firming resulting from balance sheet normalization would be modest. 

▪ From this discussion, we do not believe that views of balance sheet normalization have meaningfully affected the median dots. 

For some time, participants’ median projection for the unemployment rate has shown it declining below the  NAIRU and remaining there. “Several” participants “endorsed” this policy approach. ▪ These participants noted that the NAIRU was difficult to measure and that evidence suggested that  

resource pressures generated “only modest” responses of nominal wage growth and inflation. ▪ Moreover, they cited the benefits of following this policy approach, which included supporting a faster pace of nominal wage growth that would boost inflation expectations and help push inflation closer to the objective.  

▪ The benefits cited also included a stimulus to labor force participation, often cited as a lasting benefit of a period of a “hot” labor market.  

▪ Interestingly, it was also suggested that “modestly” overshooting the inflation objective “for a time”  following a period when inflation was persistently below the objective might underscore the symmetry of the inflation objective. 

▪ Several other participants disagreed with such an approach. They noted that a “substantial and sustained”  undershoot of the NAIRU might increase the risk of financial instability or lead to a “sharp” rise in inflation  “that would require a rapid policy tightening” and increase the risk of a recession. 

▪ On balance, the Committee seems comfortable with a sustained, though modest, undershoot of the  NAIRU. 

The discussion in the minutes provided explanations for how participants adjusted their inflation projections in response to the lower-than-expected inflation and their unemployment rate projections in response to the sharper-than-expected decline in the unemployment rate.  

▪ The lower-than-expected rate of core inflation led participants to revise down their projections for inflation in 2017. But their expectation that this reflected temporary and idiosyncratic developments is reflected in the fact that there was no change in their inflation projections for 2018 and 2019. 

▪ However, despite the stronger outlook for growth and lower path of the unemployment rate, the balance of risks to participants’ inflation projections shifted down slightly. ▪ Although fewer participants incorporated fiscal stimulus in their projections (“fewer than half” in June vs.  “about half” in March), and “a couple” who did downwardly revised the degree of stimulus, the median growth projection for 2017 shifted up by two tenths and the median projections for 2018 and 2019  remained unchanged.

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