Putting on a Brave Face

The minutes of the June FOMC meeting did not affect our view that the FOMC will raise rates four times in  2018, three times in 2019, and once more in 2020. The discussion of the appropriate pace of rate hikes did not expand much at all beyond what was already apparent from participants’ fund’s rate projections—that the fund’s rate is no longer that far from neutral and that they want to raise rates gradually over the next couple years until the fund’s rate is “at or somewhat above” neutral. And, while the Committee considered the usual wide range of upside and downside risks to activity and inflation, none seemed especially troubling to them— 

at least at this point. 

We were somewhat surprised that the minutes did not describe participants as wanting to be especially cautious with further hikes once the funds rate nears neutral, as we’d seen this as an emerging theme in  FOMC participants’ public remarks, most notably Powell’s recent speech. While there was a lack of explicit discussion about this topic in these minutes, we still expect that policymakers will be increasingly tentative with further rate hikes once the fund’s rate approaches neutral, especially if growth is clearly moderating at that point, as we and the Committee are projecting. As such, we remain comfortable with our call that there will be a brief pause in rate hikes in mid-2019 before the FOMC takes the funds rate modestly into restrictive territory in late 2019 and 2020. 

The description of the U.S. economy was upbeat. That robust outlook was still supported by factors including  “a strong labor market, stimulative federal tax and spending policies, accommodative financial conditions,  and continued high levels of household and business confidence.” It was noted that “Participants viewed  recent readings on spending, employment, and inflation as suggesting little change, on balance, in their  assessments of the economic outlook.” The labor market was described as strong, though no special attention was drawn to the fact that the unemployment rate had declined three-tenths since the previous meeting after six months at 4.1%. 

There was also no meaningful change in the outlook for core inflation, though it was noted that higher energy prices had lifted the outlook for headline inflation. Participants were generally pleased with the inflation  outlook: “The generally favorable outlook for inflation was buttressed by reports from business contacts in  several Districts suggesting some firming of inflationary pressures; for example, many business contacts  indicated that they were experiencing rising input costs, and, in some cases, firms appeared to be passing  these cost increases through to consumer prices.” 

The description of concerns about the inflation outlook was quite bland. Doves expressed some concern about  low inflation expectations (“a few participants cautioned that measures of longer-run inflation expectations  derived from financial market data remained somewhat below levels consistent with the Committee’s 2  percent objective”); on the other hand, “Some participants raised the concern that a prolonged period in which  the economy operated beyond potential could give rise to heightened inflationary pressures or to financial  imbalances that could lead eventually to a significant economic downturn.” Powell has mentioned his concerns about a hot economy potentially stoking financial imbalances a couple of times since the meeting.  We also note that this reference linked a positive output gap—rather than a negative unemployment-rate  

gap—to higher inflationary pressures. Monetary policymakers often tell the Phillips curve story in terms of the link between labor market slack and inflation, rather than in terms of the output gap. However, we don’t see this as having policy implications. Instead, it likely suggests a desire to avoid talking about the unemployment rate being “too low” for political reasons. 

Risks to the outlook were seen as “roughly balanced,” though participants appeared to list a greater number  of downside risks, including trade policy and “political and economic developments in Europe and some  EMEs.” There was clearly greater concern about downside risks related to trading policy expressed at this  meeting: “Most participants noted that uncertainty and risks associated with trade policy had intensified and  were concerned that such uncertainty and risks eventually could have negative effects on business sentiment  and investment spending.” However, concerns were still mostly about potential negative effects rather than 

actual negative effects. The reports were generally anecdotal. For example, “contacts in some Districts  indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over  trade policy.” While contacts expected higher prices for steel and aluminum as a result of tariffs on imports,  they “had not planned any new investments to increase capacity.” Contacts in the agricultural sector “were  concerned about the effect of potentially higher tariffs on their exports.” While there was clearly greater concern about tariffs, there was no clear indication of how great these risks were perceived to be or how much they might influence monetary policy. 

The commentary on the changes to the language in the FOMC statement was uninformative. The removal from the June statement of the language on the fund’s rate remaining, “for some time, below levels that are expected to prevail in the long run” was uncontroversial and anticipated. No change was made to the wording “the stance of monetary policy remained accommodative” despite some debate and Brainard’s different characterization (“modestly accommodative”) in a speech leading up to the meeting. Moreover, the minutes did not provide hints as to when this wording might change. 

Policymakers disagreed on the extent to which a flattening yield curve and potential inversion might signal an economic slowdown. “Some” argued that a long list of mitigating factors suggests that the term slope is less reliable as a recession indicator, while “several others,” thought such factors weren’t distorting the recession signal as much. The minutes did not offer the conclusions of a staff presentation on “an indicator of the  likelihood of recession based on the spread between the current level of the federal funds rate and the  expected federal funds rate several quarters ahead derived from futures market prices.” Such a model might not face the same problems as models using the slope of the Treasury yield curve, which is influenced by the compression of the term premium. However, a recent Fed staff note on the same issue concluded that “for  predicting recessions, such measures of a ‘long-term spread’…are statistically dominated by a more  economically intuitive alternative, a ‘near-term forward spread’…the current level of the near-term spread  does not indicate an elevated likelihood of a recession in the year ahead, and neither its recent trend nor survey-based forecasts of short-term rates point to a major change over the next several quarters.”1 

The decision to make a technical adjustment to the IOER-EFFR spread was telegraphed clearly in the May minutes and widely expected at the June meeting. While FOMC participants appeared to support this in a  unanimous manner, adjustments to the IOER rate are—strictly speaking—the purview of the Federal Reserve  Board and not of the FOMC. The Markets Group cited higher T-bill issuance and the consequent firmness in repo rates as one factor possibly contributing to the firmness in the effective fed funds rate. It also noted that  MBS reinvestment purchases will likely cease in the fall of 2018 as a result of higher runoff caps. 

There was no discussion of longer-term balance sheet issues in the June minutes, but again it was suggested that FOMC participants should return to the subject. “A few” advocated a discussion would be needed “before  too long” on the optimal configuration of the balance sheet for efficient and effective monetary policy  

1 Engstrom, Eric, and Steve Sharpe (2018). “(Don’t Fear) The Yield Curve,” FEDS Notes. Washington: Board of Governors of the Federal Reserve System, June 28, 2018, https://doi.org/10.17016/2380-7172.2212.

implementation once the amount of reserve balances falls “appreciably below” recent levels—a repeat of the concern from the May minutes.

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