We read the September FOMC meeting minutes as fully consistent with our call of an October rate cut. While FOMC participants were for the most part not assuming they would cut further after the September meeting, there’s a sense that they saw a substantial likelihood that they would. A Committee that was very anxious that a clear slowdown in manufacturing, trade, and investment might extend to a broader slowdown in hiring and weighing on consumer spending.
While household spending was seen as likely to “remain on a firm footing,” supported by a strong labor market, there was a pervasive sense of unease that this might not last:
▪ ”Several participants mentioned that uncertainties in the business outlook and sustained weak investment could eventually lead to slower hiring, which, in turn, could damp the growth of income and consumption.”
▪ “A few participants observed that it would be important to be vigilant in monitoring incoming data for any sign of softening in labor market conditions.”
▪ “Several participants commented that, in the wake of this increase in downside risk, the weakness in business spending, manufacturing, and exports could give rise to slower hiring, a development that would likely weigh on consumption and the overall economic outlook.”
▪ “One risk that the economy faced was that the softness recorded of late in firms’ capital formation, manufacturing, and exporting activities might spread to their hiring decisions, with adverse implications for household income and spending.”
Since that meeting, we’ve got the requisite concerning data, notwithstanding that job gains still look solid, and the market-implied probability of an October cut has risen to about 80%. That points to an October cut.
Notably, the September minutes provided very little indication of any inclination on the part of the FOMC to push back against the market in terms of rate cut expectations. Only “a few” were uncomfortable with the gap between market expectations of further easing and the FOMC’s own inclinations to the extent that they thought it might behoove the FOMC to “seek a better alignment,” presumably through forwarding guidance leaning to the tighter side. “Several” suggested that the statement should “provide more clarity” on whether the “recalibration” of the level of the policy rate would likely cease, but the September statement did not do so. The FOMC appears very much to be taking things meeting by meeting.
The September FOMC meeting represented another instance of FOMC participants and Fed staff suggesting there have been substantial changes to the outlook yet presenting little-changed baseline forecasts for growth, inflation, and the unemployment rate. What explains this? First, as the minutes noted, while participants’ “views of the most likely outcomes for economic activity and inflation had changed little,” “most” had assumed a “somewhat more accommodative path for policy” would be required to achieve that. Second, the risks to that little-changed baseline forecast had shifted further to the downside.
In other words, this rate cut was about both offsetting downward revisions to the baseline forecast and about defending against increased downside risks. On the baseline forecast: “although readings on the labor market and the overall economy continued to be strong, a clearer picture of protracted weakness in investment spending, manufacturing production, and exports had emerged.” On the balance of risks: “downside risks to the outlook for economic activity had increased somewhat since their July meeting, particularly those stemming from trade policy uncertainty and conditions abroad.”
“Many” participants also cited inflation or inflation expectations as a justification for easing, but that seemed like a bit of an afterthought. It was noted that, “notwithstanding some stronger recent monthly readings on inflation, the 12-month rate was still below 2 percent” and that “some estimates of trend inflation were also below 2 percent.” “Several” participants also cited survey and market data as pointing “to the possibility that inflation expectations were below levels consistent with the 2 percent objective or could soon fall below such levels.” Given all that, “participants suggested that a policy easing would help underline policymakers’ commitment to the symmetric 2 percent longer-run objective.” That reads as quite opportunistic. It wasn’t negative inflation surprises since the previous FOMC meeting that led the FOMC to cut rates in September. And neither were survey- or market-based indicators of inflation expectations—which have been low for a while—primary motivators. The rate cut was clearly primarily about a softer baseline outlook for growth (before accounting for more-accommodative policy) and perceptions of a heightened risk of a more severe slowdown. Of course, those changes to the outlook for economic activity imply corresponding changes to the outlook for inflation, but in this case, that was far from the primary consideration.
There is little in these minutes to suggest that the unexpected two-tenths decline in the unemployment rate in September will dissuade the FOMC from cutting rates further. FOMC participants have little faith in their estimates of the NAIRU. At the September meeting, “A couple of participants noted that, with inflationary pressures remaining muted and wage growth moderate even as employment and spending expanded further, they had again adjusted downward their estimates of the longer-run normal unemployment rate.” That’s indicative of how we expect FOMC participants to respond to the September jobs report, which—in addition to a decline in the unemployment rate—featured a very soft average hourly earnings print.
We don’t see the opposition to the September cut as numerous or convincing enough to prevent the October cut. Only “several” participants opposed the September easing; the rest were in favor. Two of those thoughts that further easing at that point was excessive insurance. They cited the argument that policymakers should keep their powder dry for when it is truly needed. (In contrast, Powell explicitly disagreed with that logic.) Only “a few” were uncomfortable with the gap between market expectations of further easing and the
FOMC’s own inclinations to the extent that they thought it might behoove the FOMC to “seek a better alignment,” presumably through forwarding guidance leaning to the tighter side.
The discussion of financial market developments seemed to center on the decline in longer-term Treasury yields and the relationship between domestic and foreign longer-term rates, especially in the context of yield curve indicators pointing to a higher likelihood of a recession in the medium term. They “observed” that an important cause of the decline in U.S. Treasury yields came from flight-to-safety flows, which were in turn caused by worries about global growth risks, global data flow, and trade tensions. Low foreign interest rates “were also considered an important influence.” However, they disagreed on what falling U.S. yields meant for the U.S. outlook. “Some” thought that an inversion that is “prolonged” could be concerning.
Recent data revisions also featured in several places through these minutes. Board staff “revised up its estimate of the level of trend productivity in recent years,” a change which, along with a lower NAIRU, “led to a somewhat higher projected path for potential output, implying that estimates of the current and projected resource utilization was less tight than the staff previously assumed.” It was also noted that the staff’s “core PCE price inflation forecast for this year was revised down to reflect recent data as well as downward-revised data for earlier in the year from the BEA’s annual revision.” As for FOMC participants, “a number” of participants “noted that, although the labor market was clearly in a strong position, the preliminary benchmark revision by the Bureau of Labor Statistics indicated that payroll employment gains would likely show less momentum coming into this year when the revisions are incorporated in published data early next year.”
Finally, “a couple of participants pointed out that data revisions announced in recent months implied that the economy had likely entered the year with somewhat less momentum than previously thought.”
The FOMC also continued their discussion of the framework review. We will comment on those discussions separately.
Balance Sheet Issues
At the September FOMC meeting, the Fed/FOMC lowered the IOER and ON RRP rates by an additional five basis points beyond the 25-basis-point easing made to the target range for the federal funds rate. Daily repo operations by the New York Fed began shortly before the FOMC meeting and have continued since then.
To recap: Strains in money markets became evident at the beginning of that week when the effective fed funds rate (median) printed at the upper bound of the target range (2.25%) and the 75th percentile (2.45%) was well above the target range. Overnight GC repo rates also rose.
Tuesday morning, before the FOMC meeting began, the New York Fed announced and conducted temporary open market operations (TOMOs).
On Tuesday, the FOMC meeting included the routine “Developments in Financial Markets and Open Market Operations” on Tuesday. The SOMA manager pro tem (Lorie Logan) noted that money market conditions were stable over “most” of the intermeeting meeting, but conditions immediately before the FOMC meeting became “highly volatile” as a result of tax payment schedules and Treasury settlements. Powell and Clarida cited the same factors recently. Logan also noted that “some banks” were keeping “significantly” more reserves than survey responses suggested were their lowest comfortable level. She summarized the decision to conduct an overnight repo operation on Tuesday morning and described how the market came to expect (for example, as we did) additional open market operations and the likelihood of an IOER adjustment of -5bps.
On Wednesday, there was a discussion of “recent money market developments.” Usually, the briefing by the Markets Group on the first day suffices. But the evolving nature of money market strains and the New York Fed’s responses called for another presentation on the second day. Logan presented a summary of the “most recent” events. Despite Tuesday’s repo operations, Tuesday’s fed funds rate “nonetheless printed 5 basis points” above its target range. Consequently, the Markets Group conducted another repo operation on Wednesday morning.
FOMC participants also explicitly debated the policy response. They agreed the FOMC should “soon discuss” the appropriate level of reserve balances while reiterating the previous decision to adopt the regime of “ample reserves.” That timeline has apparently been accelerated, as evidenced by Powell’s balance sheet announcement yesterday. “A few” brought up the possibility of “resuming trend growth” of the balance sheet to stabilize the level of reserves. Care was taken to emphasize the consensus view that trend growth of the balance sheet ought to be “clearly distinguished” from LSAP/QE programs.
The staff also presented the Fed and FOMC with proposals to lower (respectively) the IOER and ON RRP by an additional five basis points (beyond the one-for-one adjustment demanded by the fund’s rate target cut). The respective decision-making bodies agreed to enact these measures.
Adjusting IOER has been the FOMC’s preferred stop-gap measure to ease money market tensions. However, it has proven to be insufficient. Indeed, the September minutes did not echo the urgency in the November 2018 minutes to provide for the contingency of an intermeeting IOER cut.
As for a standing repo facility, the recent volatility did not make this a higher priority. “Several” thought “considering the merits” of such a facility would benefit the discussion on implementation, but there did not appear to have been a detailed discussion. The focus is clearly on resuming asset purchases and not on a repo facility or further IOER cuts, although those measures might strengthen the Fed’s credibility if they are
included, along with asset purchases, in the package of implementation measures at the October meeting. Clarida said a standing repo facility will be studied at future meetings.
Shortly thereafter, the New York Fed announced that it would conduct term repos (as well as overnight repos) over the quarter-end period. It has since extended the plan to offer daily overnight (and occasional term) repos, at least through early November. Shortly before the FOMC minutes came out, a number of policymakers hinted that asset purchases could resume sooner than expected. Last week, Clarida previewed that Fed will update balance sheet plans at the October meeting. On Tuesday, October 8 (yesterday), Powell announced in a speech that the FOMC “will soon announce measures to add to the supply of reserves over time.” He said they are “contemplating” resolving these technical issues by buying at the short end of the curve. He also suggested that these purchases would not prevent the Fed from continuing repo operations as well.