FOMC Minutes: Low Inflation Concerns Major Focus in Dec. 15-16 Session

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Concerns over inflation were clearly evident at the Dec. 15-16 Federal Open Market Committee (FOMC) meeting, based on minutes from the session, even as the recap noted “almost all participants agreed that the improvements that had occurred in the labor market and their confidence in a return of inflation to 2% over the medium term now satisfied the Committee’s criteria for beginning the policy normalization process.” Link.

While the FOMC minutes noted members were now “reasonably confident” of progress toward the 2% inflation goal by the Fed, there was still a major focus on inflation or the lack thereof.

Where the risks lie. Despite that “reasonably confident” view on inflation, the minutes noted, “for some members, the risks attending their inflation forecasts remained considerable. Among those risks was the possibility that additional downward shocks to prices of oil and other commodities or a sustained rise in the exchange value of the dollar could delay or diminish the expected upturn in inflation. A couple also worried that a further strengthening of the labor market might not prove sufficient to offset the downward pressures from global disinflationary forces. And several expressed unease with indications that inflation expectations may have moved down slightly.”

Given those risks, “members expressed their intention to carefully monitor actual and expected progress toward the Committee’s inflation goal.”

Energy drag continues and could keep headline inflation lower, longer. Once energy prices and non-energy commodity prices stabilized, “almost all” FOMC members indicated they saw the “the effects of the declines in those prices on headline and core PCE (Personal Consumption Expenditures) inflation would fade.” Given that resource underutilization has already “diminished appreciably and longer-run inflation expectations reasonably stable, most anticipated that tightening resource utilization over the next year would contribute to higher inflation.”

Reasonable confidence, but risks remain re: inflation. “Nearly all” FOMC members indicated they were “now reasonably confident that inflation would move back to 2% over the medium term. However, because of the recent further decline in crude oil prices, many participants judged that falling energy prices would depress headline inflation somewhat longer than previously anticipated.”

Dollar a factor and a drag on US economy. The minutes revealed that “several” members noted “the additional appreciation of the dollar would continue to hold down the prices of imported goods. Although almost all still expected that the downward pressure on inflation from energy and commodity prices would be transitory, many viewed the persistent weakness in those prices as adding uncertainty or posing important downside risks to the inflation outlook.”

The US dollar’s rise from the summer of 2014 and slowdown in foreign economic performance “particularly in emerging market economies, was likely to continue to depress US net exports for some time. Many expressed the view that the risks to the global economy that emerged late this summer had receded and anticipated moderate improvement in economic growth abroad in the coming year as currency and commodity markets stabilized.”

Additional dollar rise, commodity weakness could stress China, others a “lingering concern.” Should the US dollar continue to rise and commodity prices remain weak, the minutes noted that “could increase the stress on emerging market economies and that China could find it difficult to navigate the cyclical and structural changes under way in its economy. Several upside risks to the US outlook also were noted, including the possibility that declining energy prices could spur consumer spending more than currently anticipated.”

Market-based inflation measures still low. Since the October FOMC session, the minutes for the December gathering noted, “market-based measures of inflation compensation stayed low; some survey-based measures of longer-term inflation expectations edged down. Although many participants remained concerned about downside risks attending the outlook for inflation, a majority of participants saw the risks to the outlook for inflation as balanced.”

Risks from global economic situation on US economy “diminished.” A “general” view was noted that the downside risks to U.S economic activity from global economic and financial developments, although still material, as having diminished since late summer. In addition, new and revised information on employment in recent months had reduced earlier concerns about a possible slowing of progress in the labor market. Accordingly, taking into account domestic and international developments, most participants judged the risks to the outlook for both economic activity and the labor market to be balanced.”

Lots of focus on “gradual” relative to future rate increases, but no clear definition. Even after the initial increase in the target range, the minutes noted FOMC members indicated the “stance of policy would remain accommodative. Participants saw several reasons why a gradual removal of policy accommodation would likely be appropriate. Normalizing policy gradually would keep the stance of monetary policy sufficiently accommodative to support further improvement in labor market conditions and to exert upward pressure on inflation. Also, a number of participants pointed out that because inflation was still running well below the Committee’s objective and the outlook for inflation was subject to considerable uncertainty, it would probably take some time for the data to confirm that inflation was on a trajectory to return to 2 percent over the medium term.”

Gradual moves on the Fed funds rate “would also allow policymakers to assess how the economy was responding to increases in interest rates,” the minutes said. “In addition, by several estimates, the neutral short-term real interest rate was currently close to zero and was expected to rise only slowly as headwinds restraining the expansion receded. Moreover, the ability of monetary policy to offset the economic effects of an unanticipated economic shock remained asymmetric, and a cautious approach to normalizing policy could help minimize the risk of having to respond to a negative economic shock while the policy rate remained near its effective lower bound.”

Gradual moves expected, but readiness to slow or pick up the pace. While gradual increases in the Fed funds range was viewed as “appropriate” based on their economic outlook, the minutes noted, “participants emphasized the need to adjust the policy path as economic conditions evolved and to avoid appearing to commit to any specific pace of adjustments. They stressed the importance of communicating clearly that the future policy path could become shallower if the economic expansion weakened and inflation rose more slowly than currently anticipated, and that it could become steeper if real activity and inflation surprised to the upside. A few participants also indicated that significant risks to financial stability, should they emerge, could alter their view of the appropriate policy path.”

Slow rise for the next few years. With current forecasts from Fed members on the economy, the minutes indicated, “members expected economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate. However, they also recognized that the appropriate path for the federal funds rate would depend on the economic outlook as informed by incoming data. Members stressed the potential need to accelerate or slow the pace of normalization as the economic outlook evolved.” The minutes continued to echo the view of the Fed monitoring data to determine their actions ahead. “In determining the size and timing of further adjustments to monetary policy, some members emphasized the importance of confirming that inflation would rise as projected and of maintaining the credibility of the Committee’s inflation objective,” the minutes said. “Based on their current economic outlook, they continued to anticipate that the federal funds rate was likely to remain, for some time, below levels that the Committee expected to prevail in the longer run.”

Markets saw the rate rise coming. Quotes in financial markets and survey results “suggested that investors were quite confident that the Committee would raise the federal funds target range 25 basis points at the current meeting,” the minutes said. “Concerns among investors about the high-yield bond market increased notably in the days before the meeting after an open-ended mutual fund specializing in junk bonds suspended redemptions and closed. In their discussion, several participants commented that markets for leveraged finance had been correcting since midyear--particularly for the most risky assets, including those associated with energy firms--and noted that the widening of credit spreads in corporate bond markets appeared to be largely due to the repricing of riskier assets.”

Comments: We clearly have a Fed that is focused on the lack of inflation showing in the US economy, a Fed that is still viewing the impacts from oil prices and other commodities as “transitory,” and a Fed that is still keeping its options open relative to the size and timing of moves ahead on the range for the Fed funds rate. But it is also an uncertain Fed to a degree and one that realizes there could be economic results which will loom large in their future decisions.

The term “gradual” was sprinkled throughout the minutes, appearing some nine times relative to future policy adjustments. But the Fed perhaps wisely opted not to put a definition on what could be considered “gradual.” Markets have a history of “running” with definititions and the Fed clearly doesn’t want to be “locked in” to action ahead. And they also, as has been signaled by the Fed previously, left their options open relative to their future actions which could increase speeding the rate of increase in the range of the Fed funds rate. But reading through the recap, it certainly seems the definition of gradual is clearly toward a slow pace of monetary policy normalization.

While phrases like “almost all” and “most” were used in several locations to describe the confidence on the policy move made, the inflation questions loomed large and peppered their discussion and debate. That will now be the major focus ahead as the labor market situation appears to be one where the Fed is confident. While they are confident about inflation moving toward their goal, they don’t have bravado on that front.

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