Last week featured the first real uneasiness in U.S. financial markets since the presidential election, as the Trump bump to equities immediately after the election threatened to turn into a Trump slump. The couple of FOMC participants who commented on the volatility expected the Committee essentially to look through short-term volatility in financial markets. The more dovish policymakers continued to warn again too-aggressive rate hikes endangering progress toward to 2% inflation objective. The incoming economic data for the second quarter continue to be consistent with our expectation of a substantial rebound in growth after the slowdown in Q1.
Policymakers’ Comments
A couple of FOMC participants warned that volatility in equity prices would be unlikely to sway the Committee’s decisions regarding monetary policy. Kashkari argued that “the Fed’s job is not to protect investors. It is to promote financial stability.” He pointed to capital requirements as a better way to prepare the financial system for asset bubbles. Likewise, Mester advocated looking through short-term fluctuations, citing the business community’s willingness to do so also: “You have to look through those temporary fluctuations in both economic and financial data and focus on what the implications are for the medium-run outlook…I don’t see that affecting so far the comments I’m getting from my business contacts. So they are looking through it as well, but we’ll have to see what happens.”
FOMC participants continued to agree generally for the need for further tightening via rate hikes and changes in reinvestment policy. Mester, who tends to be more hawkish than the average FOMC participant, warned that “if we delay taking further normalization steps for too long and then find ourselves in a situation where the labor market becomes unsustainably tight, price pressures become excessive, and we have to move rates up steeply, we could risk a recession.” Williams noted that the U.S. is the best-performing advanced economy and that any downside risks would likely come from abroad rather than from within the U.S.: “Typically, I would say the threats are outside the United States…As we’ve seen the last several years, the thing that’s hurt the U.S. economy the most in the last few years [has really been kind of a] slowdown in other countries, or economic development around the world, which then feedback onto the U.S. economy.” On the dovish end of the spectrum, Kashkari argued that overeager rate hikes could endanger macro outcomes: “The cost of keeping rates high to reduce the chances for future bubbles would be higher unemployment and a risk of unanchoring inflation expectations to the downside.” Bullard argued that that financial market developments since the March meeting “suggest that the FOMC’s contemplated policy rate path is overly aggressive relative to actual incoming data on U.S. macroeconomic performance” and pointed to downside surprises in inflation and inflation expectations.