No Sign of Cracks in the “Patient” Consensus

The minutes of the May FOMC meeting suggested that the FOMC remains firmly in its patient mode and that rate adjustments are unlikely in the near term, perhaps pouring cold water on market expectations (or hopes?)  of a near-term rate cut and reinforcing that near-term rate hikes remain off the table. 

The minutes suggested that, as Powell indicated at his press conference, FOMC participants attributed some of the recent weakness in inflation to temporary factors. Participants apparently shared the view that “At least part of the recent softness in inflation could be attributed to idiosyncratic factors that seemed likely to have only transitory effects on inflation, including unusually sharp declines in the prices of apparel and of portfolio management services”—in line with Powell’s press conference remarks. “A number of participants,”  again like Powell, noted that the trimmed mean measure of PCE price inflation “had been stable at or close  to 2 percent over recent months.” 

Participants didn’t seem to have substantially changed their projections for inflation: “Participants continued to view inflation near the Committee’s symmetric 2 percent objective as the most likely outcome, but, in light of recent, softer inflation readings, some viewed the downside risks to inflation as having increased” (italics our emphasis). In addition, “Some participants also expressed concerns that long-term inflation expectations  could be below levels consistent with the Committee’s 2 percent target or at risk of falling below that level.”  We see this expression of concern about low inflation as quite weak. These minutes suggest that Powell’s tone at his post-meeting press conference was largely in line with participants’ internal discussions. 

A paragraph devoted to describing discussion of “the potential policy implications of continued low inflation  readings” only reinforced the notion that FOMC participants are very far from considering a downward  adjustment to rates solely on the basis of soft inflation (or so-called “insurance cuts”): “Many participants  viewed the recent dip in PCE inflation as likely to be transitory, and participants generally anticipated that a  patient approach to policy adjustments was likely to be consistent with sustained expansion of economic  activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective.”  Indeed, there was no explicit mention of any discussion of easing policy to address low inflation, not even in vague hypothetical terms, as some FOMC participants have recently mused. Probably the most dovish part of this paragraph was the line that “Several participants commented that if inflation did not show signs of moving up over coming quarters, there was a risk that inflation expectations could become anchored at levels below those consistent with the Committee’s symmetric 2 percent objective—a development that could make it more difficult to achieve the 2 percent inflation objective on a sustainable basis over the longer run.” Again,  a pretty soft statement of concern coming from only “several” participants, and there’s no explicit mention of whether a policy reaction would even be warranted. 

The minutes did indicate that the staff’s inflation forecast “was revised down slightly.” The downward  revision reflected “some recent softer-than-expected readings on consumer price inflation that were not  expected to persist along with the staff’s assessment that the level to which inflation would tend to move in  the absence of resource slack or supply shocks was a bit lower in the medium term than previously assumed.”  The latter part of that sentence is worth noting because it suggests that the staff marked down its assessment of underlying inflation, something that wasn’t apparent at all in participants’ discussions. The staff’s view  was that “core PCE price inflation was expected to move up in the near term but nevertheless to run just  

below 2 percent over the medium term.” Given that the staff sees the unemployment as below and likely to  “decline a little further” below the NAIRU, such an inflation forecast suggests the staff sees underlying inflation as meaningfully below 2 percent. While there was no mention of a change in FOMC participants’  inflation projections, we think the staff’s views will hold some weight, and FOMC participants’ inflation projections could be marked down in the June SEP. 

Aside from the soft incoming inflation data, there was a clear current of optimism about recent developments  leading up to the May FOMC meeting, which included a strong Q1 real GDP print, “improvements in consumer  confidence and in financial conditions,” and “diminished downside risks both domestically and abroad.” (Recall  that this was before recent negative developments with respect to U.S.-China trade and the associated  response in financial markets, however, as well as some disappointing spending data.) Both the staff and  FOMC participants marked up their real GDP growth forecasts, though the broad contours of those forecasts remained intact. The more important change in the outlook appeared to be a perception of decreased downside  risks: “Many participants suggested that their own concerns from earlier in the year about downside risks  from slowing global economic growth and the deterioration in financial conditions or similar concerns  expressed by their business contacts had abated to some extent.” But there was absolutely no hint that participants saw these improvements as making them more supportive of further rate hikes. In fact, the  minutes explicitly discouraged such an interpretation with that line that “Participants noted that even if global  economic and financial conditions continued to improve, a patient approach would likely remain warranted,  especially in an environment of continued moderate economic growth and muted inflation pressures.” 


The minutes provided a lengthy justification of the Fed’s decision to adjust IOER down by 5 basis points.  Lorie Logan, Deputy Manager of the SOMA, cited numerous factors, including federal tax receipt timing, FHLB  and depository institution lending activity, and regulatory requirements.  

Consequently, the spread between the ON RRP rate (2.25%) and IOER (now 2.35%) narrowed further to 10  basis points. The staff didn’t think a 10-basis-point spread would hinder market functioning but warned that any further reduction in IOER should prompt consideration of where ON RRP should be set—implying that ON  RRP could be reduced to below the bottom end of the fund’s rate target range (that is, below 2.25%). 

Balance Sheet Normalization 

There was considerable discussion of issues related to balance sheet normalization—including the ultimate target composition of the portfolio and ways of getting the portfolio to its final state. 

Fed staff presented two illustrative scenarios for the Fed’s Treasury portfolio maturity composition in the longer run. For each option, participants assessed the Fed’s capacity to conduct maturity extension (MEP)  and the implications for market functioning, financial stability, and the Fed’s short-term rate policy. They did not reach any decisions and noted they had “some time” until they had to do so. The maturity of the Fed’s portfolio will almost certainly be reduced; it is the extent of the reduction that is in question.  

1. Proportional: Mirror the maturity composition of the universe of all outstanding securities. The key advantage would be little effect on term premiums and therefore on the ability to cut the funds rate.  “Several,” thought it was well-aligned with the FOMC has announced that the fund’s rate would remain the primary policy instrument. “Several” argued that this choice would still leave “meaning capacity” for an Operation Twist-type program if so desired. “A couple” pointed to a “relatively flat”  yield curve that could exacerbate so-called reach-for-yield behavior. 

2. Shorter maturity: Only securities with (remaining) maturities within three years. Shorter-term yields would be lower for two related reasons, the first being that purchases of those securities would directly lower those yields. But the staff also noted that moving to a shorter maturity would put  “significant upward pressure” on term premiums (tighten financial conditions) and require that the fund’s rate be lower than otherwise to achieve the same stance of monetary policy. Policy rate 

expectations would thus be lower—the second reason that short-term yields would be lower in this scenario. There appeared to be a robust back-and-forth on the pros and cons of such an approach.  “Many” saw the advantage of such an approach being the greater capacity to undertake MEP.  “Several,” thought MEP was a useful “initial” option. While the cost of creating this policy space for  MEP was sacrificing policy space for rate cuts, “a number” suggested that estimation uncertainty meant the costs could be lower. In addition, issuance might adjust to mitigate the boost to the term premium. Others were worried that r-star could be pushed even lower, and preferred LSAPs and forward guidance to an MEP. They argued that reducing the maturity just to be able to do more MEP  might not be worth it. A “couple” observed favorably that under this approach there would be a  “narrow gap” between the maturities of the Fed’s assets and liabilities. A “few” warned of the financial stability risk from encouraging greater issuance of short-term private-sector debt. A “couple”  warned of adverse market functioning effects if the Fed held too great a share of outstanding shorter-dated Treasuries. 

For each of the alternative longer-term maturity compositions, the staff and participants also considered alternative speeds at which the portfolio might transition. The staff distinguished between two illustrative  approaches: 

1. Gradual: Reinvestment of maturing Treasuries, MBS principal payments and purchases to accommodate growth in liabilities (or growth purchases) would be directed to the longer-term target portfolio. “Several” seemed to prefer a gradual transition to minimize disruptions to financial conditions, but policymakers, in general, noted that it could take a long time to do so. This could take up to 15 years! 

2. Accelerated: Reinvestment of maturing Treasuries, MBS principal payments and purchases to accommodate growth in liabilities (or growth purchases) would be reinvested entirely into T-bills until the WAM of the portfolio reached the WAM of the longer-term target portfolio. However, maturing  Treasury securities would continue to be reinvested into coupon securities (not bills). “A few” leaned toward “some type” of accelerated transition, “perhaps” including sales of residual MBS. However, a  System economist has warned (to be clear, not in these minutes) that “there is a limited appetite  [among policymakers] to be aggressive in selling MBS,” because it is operationally complex and presents downside risk to the housing market. This plan would still take at least five years to accomplish. 

A well-thought-out communication plan was seen as key to a successful transition. “Several” participants posited that the communication of an “intermediate,” rather than longer-term, the target could be preferable. 

The FOMC also reiterated its willingness to adjust the size of the balance sheet (not only its composition) to reach its policy goals.

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