Still At Ease With Gradual Rate Hikes

The minutes of the August FOMC meeting revealed a Committee that remains very comfortable with the near-term outlook for monetary policy. In particular, a September rate hike is virtually certain. There was very little change in their economic outlook, which remained strong. There was extensive discussion of risks, mostly relating to the ongoing trade drama as well as developments abroad. However, these risks had not yet risen to a level serious enough to have affected U.S. economic and financial conditions or to be leading the FOMC  to shift policy a risk management posture. The FOMC remains comfortable continuing to remove accommodation with a gradual pace of rate hikes. Far less certain is how to proceed once the accommodation has been removed, and the minutes gave little indication that this issue was discussed at the meeting. 

September Is (Still) A Go 

“Many participants suggested that if incoming data continued to support their current economic outlook, it  would likely soon be appropriate to take another step in removing policy accommodation.” 

The outlook remained strong, driven in part by continued fiscal stimulus and accommodative monetary policy. It was noted that household spending had come in stronger than expected while residential investment had disappointed. And despite some turbulence in global financial markets, “Over the intermeeting period,  only a small change in overall financial conditions occurred, with modest movements on the net in equity prices  and in the foreign exchange value of the dollar.” 

The labor market continued to exhibit strong momentum and was seen as tight, though “A few participants  suggested there could still be some labor market slack, citing recent increases in labor force participation  rates relative to prevailing demographically driven downward trends.” 

Risks to the inflation outlook were characterized as quite balanced—perhaps surprisingly, given that inflation  is currently near 2 percent and the unemployment rate being below the NAIRU and headed lower: “Many  participants anticipated that, over the medium term, high levels of resource utilization and stable inflation  expectations would keep inflation near 2 percent.” Indeed, concerns about sustaining inflation at its 2 percent pace appear to be about as prevalent as concerns of inflation overshooting the target excessively. “Some”  were more concerned about downside risks to inflation, and “some” were more concerned about upside risks. 

Trade Policy 

Trade concerns gained prominence, although they mostly remain a risk rather than affecting the economic outlook to an extent that the expected rate path is seen as shifting. “All” policymakers cited trade disputes and proposed measures as key sources of downside risk affecting the outlook for consumption, investment,  and consumer and business sentiment. However, while the effects thus far seem to have been small, it is notable that tariffs measures are no longer merely prospective threats, but rather are leaving some imprint:  Recent increases in tariffs “had put” upward pressure on input costs. Agriculture was singled out as a  particular sector that has already experienced adverse effects. Nevertheless, there were still only limited reports of actual effects on investment; “most” businesses had not yet lessened investment or hiring even though it was a downside risk. Additionally, the FOMC views financial conditions as a key channel through  

which trade would threaten the outlook; notably, the discussion of financial conditions outlined in detail how  developments in trade tensions between the U.S. and trading partners were affecting asset prices,  “particularly in foreign exchange markets.” Their surveys of market participants indicated trade concerns had not affected market expectations of monetary policy though. The minutes were not conclusive on the potential  implications for monetary policy: “the complex nature of trade issues…presented a challenge in determining  the appropriate monetary policy response.” 

Operating / Balance Sheet Framework 

The FOMC seems to be taking its time in advancing discussions of the balance sheet framework. There was no indication of a consensus on whether the balance sheet normalization plan must be adjusted sooner than originally anticipated as a result of changes in the fed funds market. Only a couple of participants brought up balance sheet issues. Chairman Powell “suggested that the Committee would likely resume a discussion of  operating frameworks in the fall.” 

Yield Curve Flattening 

Policymakers continued to disagree on the relevance of the shape of the yield curve for the conduct of monetary policy. “Several” pointed to inversions preceding recessions, but “others” stressed that “inferring causality from statistical correlations was not appropriate,” citing changes in the financial market environment that could lessen the significance of an inversion. 

Staff Presentation on Unconventional Policy 

The staff provided a briefing on unconventional policies from the current toolkit, particularly threshold-based forward guidance and asset purchases. While the minutes stated that “the Committee’s current toolkit was judged to be effective,” the description of the discussion suggested that FOMC participants are uneasy with that toolkit: “Participants acknowledged that there may be limits to the effectiveness of these tools in addressing an ELB episode. They also emphasized that there was considerable uncertainty about the economic  effects of these tools.” There seemed to be a particular concern with relying on asset purchases: “A number  of participants indicated that there might be significant costs associated with the use of unconventional  policies and that these costs might limit, in particular, the extent to which the Committee should engage in  large-scale asset purchases.”  

FOMC participants would like to develop a more systematic approach to using their toolkit and perhaps expand  it: “Participants agreed, as a matter of prudent planning, to discuss their policy options further and to broaden  the discussion to include the evaluation of potential alternative policy strategies for addressing the ELB.” That said, the scope of the staff presentation at this meeting was very narrow and did not appear to include other possible changes to the policy framework, such as a higher inflation objective, price-level targeting, and nominal-income targeting (approaches we continue to see as very unlikely). 

Financial Stability and Countercyclical Buffer 

The staff’s report on financial stability judged vulnerabilities as “moderate on balance” while asset values were “elevated, with no major asset class exhibiting valuations” below historical norms. Vulnerabilities from leverage in the nonfinancial business sector were elevated as well. Recently, a number of regional Fed presidents have expressed support for activating the countercyclical buffer. The decision to raise it rests with the Federal Reserve Board of Governors. At this meeting, “a few” argued that higher capital requirements could reduce financial stability risks. But the minutes concluded that “arguments for and against the activation of the countercyclical capital buffer as a means of further strengthening the capital positions of large banks were discussed in this context,” which suggests that there was no obvious consensus for imminent action.

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