Not Yet Concerned, But Alert

The November minutes did not signal a significant change in the FOMC’s thinking about either the economy or policy relative to the September meeting. FOMC participants acknowledged recent developments, signaling that they were taking them into consideration but not meaningfully adjusting the outlook for policy. There was significant volatility in financial markets during the intermeeting period, which included a substantial decline in equity prices and increased concerns about a slowdown in global growth. It was noted that “participants observed that financial conditions tightened over the intermeeting period, as equity prices  declined, longer-term yields and borrowing costs for most sectors increased, and the foreign exchange value  of the dollar rose.” But the next sentence downplayed the tightening: “Despite these developments, a number  of participants judged that financial conditions remained accommodative relative to historical norms.” FOMC  participants seemed to incorporate the change in financial conditions into the outlook as the staff did, as a  moderate tightening in financial conditions that didn’t warrant any fundamental change in the outlook. Of course, equity prices had rebounded from their lows by the time of the November FOMC meeting, and they fell again thereafter. However, we doubt the FOMC would have been seriously shaken by any subsequent developments. And there is no sense in the minutes that the FOMC was considering the narrative that market volatility suggested the FOMC was tightening too much. 

Only “a few” participants saw a recent increase in uncertainty, and they pointed “to the high levels of  uncertainty regarding the effects of fiscal and trade policies on economic activity and inflation.” “Some” saw  “economic and financial developments abroad, including the possibility of further appreciation of the U.S.  dollar, as posing downside risks for domestic economic growth and inflation”—hardly a signal of alarm.  Notably, participants did not mention any specific concerns here, such as Brexit. The summary of participants’  discussion of risks and uncertainties concluded with the line, “In general, participants agreed that risks to the  outlook appeared roughly balanced.”  

The outlook for the U.S. economy was still seen as strong despite adverse developments such as the tightening in financial conditions and the slowdown in global growth: “Participants generally indicated little change in their assessment of the economic outlook, with above-trend economic growth expected to continue before slowing to a pace closer to trend over the medium term” When FOMC participants did acknowledge areas of weakness in the incoming data, they did so without signaling concern about the underlying strength of the expansion. For example, weakness in housing was noted by “most” participants. It was attributed to  supply factors (cost increases, supply constraints) as well as “increased mortgage rates.” This is one example of the FOMC acknowledging the effect of its tightening (in this case via higher mortgage rates) gaining traction in the real economy. “Higher interest rates” were also mentioned as one of several factors possibly contributing to the slowdown in the growth of business fixed investment in Q3. As with housing, FOMC  participants seemed to acknowledge this slowdown in the data without signaling any alarm. 

The labor market was again described as tight and getting tighter, with both the data and anecdotal reports in agreement. The minutes described only one area of debate among participants about the labor market, and  it didn’t seem to be much of a debate: “A couple of participants saw scope for further increases in the labor  force participation rate as the strong economy pulled more workers into the labor market, while a couple of  other participants judged that there was little scope for significant further increases.” Board Vice-Chair Clarida is likely in the former group, as he’s made points along these lines in his public remarks. There seemed to be  a strong consensus that wages were firming: “Participants observed that, at the national level, measures of  nominal wage growth appeared to be picking up.” 

The outlook for inflation was similarly described as little changed: “In general, participants viewed recent price  developments as consistent with their expectation that inflation would remain near the Committee’s  symmetric 2 percent objective on a sustained basis.” There was no mention of recent monthly readings on core inflation being somewhat softer. The limited discussion among participants of inflation focused on reports that “were consistent with some firming with some firming in inflationary pressure,” with higher input costs being a theme. 

Consistent with the modest changes in the macro outlook, participants didn’t reveal any significant changes in their views on the appropriate pace of rate hikes. “Almost all” reaffirmed the need for “further gradual  increases.” “Almost all” saw another hike as likely to be warranted “fairly soon” (December). But “a few”  thought that the “timing” of such “further gradual increases” was uncertain. “A couple,” said the funds rate  “might currently be near its neutral level and that further increases in the federal funds rate could unduly slow  the expansion of economic activity and put downward pressure on inflation and inflation expectations.”  Participants also stressed that policy “was not on a preset course,” and they did hint, in an even-handed way,  that they would take into account recent developments: “Various factors such as the recent tightening in  financial conditions, risks in the global outlook, and some signs of slowing in interest-sensitive sectors of the  economy on the one hand, and further indicators of tightness in labor markets and possible inflationary  pressures, on the other hand, were noted in this context.” 

The minutes also suggested that the FOMC will soon reconsider the “further gradual increases” language in  the statement, wording which remained unchanged in the November statement: “Many participants indicated  that it might be appropriate at some upcoming meetings to begin to transition to statement language that  placed greater emphasis on the evaluation of incoming data in assessing the economic and policy outlook.” 

A significant portion of the discussion seemed to be devoted to financial stability, but we didn’t see this as having implications for monetary policy. There was likely a heightened focus on this topic in part because the  Financial Stability Report was soon to be published. The discussion largely mirrored the conclusions of the  Report. “A few” thought financial stability vulnerabilities “represent downside risks to the economic outlook.” 

Shortly before the November meeting, the EFFR-IOER spread narrowed to zero. However, this did not appear to have immediate implications for the path of balance sheet normalization, a passive tool policymakers preferred to keep in the background. Policymakers signaled a strong likelihood of a further technical adjustment in the IOER rate at the December meeting (raising IOER by 20bps instead of by 25bps, as in June).  Policymakers saw “some” risk that the effective fund’s rate could drift higher in the meantime. There was some surprising anxiety about keeping the fund’s rate “well within” its target range, judging by the news that participants had agreed, as a “contingency plan,” that it might be appropriate for the Board to implement an adjustment before the December meeting. This would be implemented as an outright cut in the IOER rate  (likely 5bps) during the intermeeting period. However, such a cut would be unlikely as it would be a considerable challenge to communicate. The effective rate has been trading at IOER (2.20%) almost continuously since the November meeting.  

There was also a lengthy discussion on long-run policy framework issues. Policymakers reiterated their preference for the current regime with abundant reserves. We shall explore the detailed implications in a  separate note.  

At the end of the minutes, there was a description of an update from the Subcommittee on Communications,  in which the review of the Fed’s strategic framework was described and proposed. This description was essentially the same as the press release we’ve already seen announcing this initiative.

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