FOMC Minutes: June Remains Live for Rate Increase

Fed moving toward plan on balance sheet

Despite a downbeat first quarter of 2017, “most” Fed members indicated that if economic results unfolded as they expect, it would “soon” be appropriate to take another step to tighten monetary policy, according to minutes (link) of the May 2-3 Federal Open Market Committee (FOMC) meeting.

“Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation,” the minutes stated.

Even as the Fed opted to keep monetary policy steady, the minutes noted there were “a couple of participants” who backed increasing rates at the May session based on their economic outlook. But those participants also said that “maintaining the current stance of policy for now would be consistent with the Committee’s gradual approach or that the Committee’s recent communications had not pointed to an increase at this meeting.”

The weak showing in the first quarter of 2017 also was a discussion point, with Fed members mostly taking the view that it was “transitory” and they noted some increase in data at the end of the quarter that had them optimistic about prospects ahead.

Interestingly, even as the minutes noted that if the economic data unfolded as they expect that it would be appropriate to increase rates “soon,” the minutes also stated, “Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation.”

As for consumer spending, the minutes indicated “a few emphasized the uncertainty with regard to the reasons for the unexpected weakness in consumer spending but considered it too early to judge the implications for the outlook.”

The situation in Washington with fiscal policy changes also was a discussion point. “Many participants continued to view the possibility of expansionary fiscal policy changes in the United States as posing upside risks to their forecasts for US economic growth, although they also noted that prospects for enactment of a more expansionary fiscal program, as well as its size, composition, and timing, remained highly uncertain,” the minutes said.

As for the balance sheet, FOMC members agreed to continue the current policy of reinvestment of maturing securities. But a discussion of options also took place again at this session. Fed staff delivered a briefing on possible approaches on this front to reduce the balance sheet “in a gradual and predictable manner.”

The proposed approach would see the Fed announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month, the minutes said.

“Nearly all policymakers expressed a favorable view of this general approach,” the minutes stated. Plus, Fed members also felt that “preannouncing a schedule of gradually increasing caps” would be “consistent with the Committee’s intention to reduce the Federal Reserve’s securities holdings in a gradual and predictable manner as stated in the Committee’s Policy Normalization Principles and Plans.”

Further, limiting the size of the monthly reductions in securities holdings “could help mitigate the risk of adverse effects on market functioning or outsized effects on interest rates.” The approach would also likely be straightforward to communicate. Moreover, under this approach, the process of reducing the Federal Reserve’s securities holdings, once begun, could likely proceed without a need for the Committee to make adjustments as long as there was no material deterioration in the economic outlook.

Fed members agreed the normalization plans should be “augmented soon to provide additional details about the operational plan to reduce the Federal Reserve’s securities holdings over time.”

As for timing on action relative to the balance sheet, “Nearly all policymakers indicated that as long as the economy and the path of the federal funds rate evolved as currently expected, it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year,” the minutes said. There was also agreement on continuing the discussion in June on the policy.

Policymakers agreed to continue their discussions in June on plans for a change to the Committee’s reinvestment policy.

Comments: Lots to focus on from the meeting recap. The Fed acknowledged slow growth in the first quarter but held they view it was transitory – the same stance they have taken previously on things like energy prices. But there are still some who would like to see some confirmation before moving the range on the Fed funds rate higher. And their comments indicated that an adjustment could come “soon” which is widely seen as June, especially with at least two members even wanting to raise rates at the May meeting.

The balance sheet plan from the Fed is also taking shape. The use of caps that gradually are adjusted to trim the balance sheet appears to be the path Fed policy-makers are wanting to follow. If that is the case, then it truly could be “like watching paint dry” as was related this week by Philadelphia Fed President Patrick Harker. The key point now will be on the level that Fed members agree to keep the balance sheet at once their plan is allowed to run its course. Many believe that the level is not likely to return to the pre-crisis levels, but stay somewhere above that mark. That should now become the focus for markets as they look ahead.

However, the first focus will now be on assessing economic data ahead of the June 13-14 FOMC meeting. Since the release of the minutes, the CME FedWatch tool has risen over 83 percent relative to the odds for a June rate rise after being around 78 percent prior to the release.