Somewhat Dovish, Though No Big Surprises

There were few surprises in the minutes of the May FOMC meeting. The economic outlook was described as virtually unchanged relative to the previous FOMC meeting. It was noted that markets saw a June hike as a  near-certainty, and the minutes concurred: “Most participants judged that if incoming information broadly  confirmed their current economic outlook, it would likely soon be appropriate for the Committee to take  another step in removing policy accommodation.” However, these minutes did strike us as having a somewhat dovish tilt, on balance, specifically because of the discussion of the inflation outlook and the neutral fund’s rate. These minutes were markedly more emphatic about characterizing the inflation objective as “symmetric”  and about reaching that objective “on a sustained basis.” FOMC participants appeared to embrace the potential for a slight overshoot of the 2% inflation objective, and there was little concern expressed about the prospect of getting behind the curve. 

FOMC participants were pleased with the recent inflation data and the outlook for inflation: “Many saw tight  resource utilization, the pickup in wage increases and nonlabor input costs, and stable inflation expectations  as supporting their projections that inflation would remain near 2 percent over the medium term” and “Most  participants viewed the recent firming in inflation as providing some reassurance that inflation was on a  trajectory to achieve the Committee’s symmetric 2 percent objective on a sustained basis.” They saw recent developments as indicating that the slowdown last year was transitory. But FOMC participants also stressed  that, despite inflation having essentially reached 2 percent, they hadn’t declared victory in the battle against  below-target inflation: “In discussing the outlook for inflation, many participants emphasized that, after an  extended period of low inflation, the Committee’s longer-run policy objective was to return inflation to its  symmetric 2 percent goal on a sustained basis.” 

We saw the discussion of inflation as overall on the dovish side because when an overshoot was mentioned,  it was seen as a welcome prospect. “Some” participants, a perhaps surprisingly small cohort, noted inflation  was likely to “modestly overshoot 2 percent for a time.” But this statement, which wasn’t even an expression  of concern, was immediately followed by the dovish counterpoint: “However, several participants suggested  that the underlying trend in inflation had changed little, noting that some of the recent increase in inflation  may have represented transitory price changes in some categories of health care and financial services, or  that various measures of underlying inflation, such as the 12-month trimmed mean PCE inflation rate from  the Federal Reserve Bank of Dallas, remained relatively stable at levels below 2 percent.” 

In another section, “a few” participants commented that recent inflation data, as well as an outlook for solid  growth, “supported the view that inflation on a 12-month basis would likely move slightly above the  Committee’s 2 percent objective for a time.” This was generally viewed as a positive development: “It was  also noted that a temporary period of inflation modestly above 2 percent would be consistent with the  Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations  at a level consistent with that objective.” Elsewhere, “a few cautioned that, although market-based measures  of inflation compensation had moved up over recent months, in their view these measures, as well as some  survey-based measures, remained at levels somewhat below those that would be consistent with an  expectation of sustained 2 percent inflation as measured by the PCE price index.” It is difficult to discern  

how widespread the concern about low inflation expectations is on the Committee. While these “few” doves have expressed these doubts for a long time, we suspect their policy views are far from the consensus. 

The minutes described in vague terms what was likely an in-depth discussion of the path of the fund’s rate:  “Participants indicated that the Committee, in making policy decisions over the next few years, should  conduct policy with the aim of keeping inflation near its longer-run symmetric objective while sustaining the  economic expansion and a strong labor market.” This discussion appears to have been motivated at least in part by a need to adjust the language in the post-meeting statement, which describes the monetary policy as being accommodative and the fund’s rate as likely to remain below its longer-run levels for some time. We expect them to revise this language, most likely in the June post-meeting statement. “A few” participants noted that  “the federal funds rate could be at or above their estimates of its longer-run normal level before too long,”  and “a few observed that the neutral level of the federal funds rate might currently be lower than their  estimates of its longer-run level.” These were small numbers of participants—just “a few”—but the lack of any discussion on the other side to balance it out also gave a bit of a dovish tilt, on balance, to the discussion. 

A number of other topics were also discussed. Substantial fiscal stimulus is still expected, but FOMC  participants expressed considerable uncertainty about the timing and size of the effects. The discussion suggested that policymakers prefer to be in a “wait-and-see” mode and to await concrete evidence of the actual impact rather than preemptively tightening policy in anticipation of the projected effects. Trade policy remained a significant source of uncertainty. Indeed, we were somewhat surprised by the amount of concern expressed about trade disruptions, which seemed greater than noted in the previous minutes. Participants cited anecdotal evidence of adverse effects from changes in trade policy. Not only could activity be affected in the future, but protracted negotiations could also be adversely affecting capital spending in the present as well. Uncertainty about the unusually wide range of outcomes was seen as an unambiguous negative for sentiment. 

The prospect of a yield curve inversion weighed on some policymakers. Though not a majority, “several”  participants (four or five) who suggested that an inversion would change their policy inclinations slightly outnumbered the “few” (two to three) who cited mitigating factors as making the slope a less reliable indicator. This characterization aligns with our tracking of recent remarks by policymakers. 

The Board staff also gave its periodic financial stability assessment and continued to indicate vulnerabilities  as “moderate.” Participants pointed out that valuations “across a range of markets” and nonfinancial corporate  leverage remained “elevated,” which left some susceptible to “unexpected negative shocks.” But we don’t see participants’ concern as having any effect on monetary policy. Instead, the minutes emphasized the need for continuing regulation. 

The recent compression of the FF-IOER spread, which has resulted in the effective fund’s rate trading near the top of its target range, was discussed by Lorie Logan (the deputy manager of the Markets Group at the New  York Fed). Participants “generally agreed” to enact her proposal to adjust the IOER rate such that it would no longer be equal to the top of the fund’s rate target range, but rather five basis points below the upper bound.  The intent would be to guide the fund’s rate away from the upper bound back toward the midpoint of its 25- 

basis-point target range. Policymakers appear to be inclined to make this adjustment “sooner rather than  later.” Therefore, in June, when the FOMC almost certainly will raise the fund’s rate target range from 1.50%- 1.75% to 1.75%-2.00%, we expect them to raise the IOER rate from 1.75% to 1.95%. 

Additionally, the markets group expected MBS principal reinvestment to cease by year-end. Although there  was no detailed discussion on the longer-run balance sheet policy framework, the debate will likely resume  soon: “A number of participants also suggested that, before too long, the Committee might want to further  discuss how it can implement monetary policy most effectively and efficiently when the quantity of reserve  balances reaches a level appreciably below that seen in recent years.”

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