Comments from Fed policymakers were consistent with our expectation that the balance sheet runoff announcement will be in September but the next rate hike will not come until December.
Williams wrote in his speech that it would be appropriate to start unwinding the balance sheet “this fall.” He thought that the September meeting would be an appropriate time, but also noted that there would be “no discernible effect” on the macro economy between announcing runoff in September versus December. He saw the debt-ceiling debate as a possible risk factor, but he was “hopeful that we will find a way to resolve this uncertainty around the debt ceiling issue in a timely manner.” In his mind, “it should take about four years to get the balance sheet down to a reasonable size.” Mester describing the planned balance sheet runoff as a “gradual unwinding” and did not expect a “major impact on the long end of rates.”
The tension between the strong labor market and still-subdued inflation continued to be debated. Mester, whom we see as being on the more hawkish side, pointed to more uncertainty in the inflation picture: “So far I still think the factors are in place for inflation to rise. I don’t want to overreact to a couple reports on inflation. At the same time, there could be something more going on and I want to look at the data.” In her speech, she noted that inflation continuing to stay moderate has convinced her to lower her NAIRU estimate from 5 percent to 4.75 percent. Nonetheless, she cautioned that “We can’t wait until the goals are fully met because monetary policy affects the economy with a lag. We need to remain focused on the medium-run outlook, and risks around the outlook.” She still saw the outlook as providing the conditions for inflation to return to 2 percent next year. Williams’ timeframe for a return to 2 percent was slightly longer; he noted that, “While we’ve reached our employment goal, we still have a ways to go in terms of inflation…As these transitory factors wane and with the economy doing well, I expect that we’ll reach our 2 percent goal in the next year or two.” He also thought that “We need to see the economy slow down a little bit…We don’t want to let this go too long — because I think eventually inflation pressures will emerge.” He warned that continued strengthening of the labor market might create inflation risks: “I do want to see inflation move up a little bit…if job growth continues at this 180,000 number, we’re going to see unemployment just going further and further below and that will create risks.” He saw potential growth as “around 1.5 percent for the foreseeable future, the slowest pace in our lifetimes.” Bullard saw the inflation outlook as having “deteriorated” this year: “It’s possible data will turn around, but we’ll have to see.”
Williams thought that the pace implied by the median dots from the June meeting (one more hike in 2017 and three hikes in 2018) “still makes sense” and that his economic outlook would warrant “Maybe one more increase this year and something like three increases next year.” But he also took r-star into account: “We’re kind of halfway [to r-star] already…So even for someone like me who is optimistic about inflation moving back, I still don’t see the need to raise rates quickly because we don’t have that long to go to get to a neutral interest rate.” Bullard continued to advocate for no further rate hikes: “Given the inflation outlook, which has deteriorated in 2017, I would not support further moves in the near term…I think for now we should remain on pause.” He reiterated his thesis that the current regime is “low interest rate, low growth, [and] low inflation,” which would mean that the fed funds rate should not move up. According to him, another rate hike “would probably inhibit inflation from moving towards 2 percent.”