From ‘transitory’ to ‘idiosyncratic factors’
Views were split on when the Federal Reserve will hike interest rates during the July 25-26 Federal Open Market Committee (FOMC) meeting as Fed officials struggled with the sluggish inflation in the U.S. economy, according to minutes of the session released today (August 16).
Gradual still the approach, but... Fed officials still believe there will only need to be a gradual pace in terms of increasing short-term interest rates in the future. While still holding the view that “inflation would stabilize around the Committee’s 2% objective over the medium term.” But “some” on the Fed noted “concern about the recent decline in inflation, which had occurred even as resource utilization had tightened, and noted their increased uncertainty about the outlook for inflation.”
Those expressing concern on inflation took the view the FOMC “could afford to be patient under current circumstances in deciding when to increase the federal funds rate further and argued against additional adjustments until incoming information confirmed that the recent low readings on inflation were not likely to persist and that inflation was more clearly on a path toward the Committee’s symmetric 2 percent objective over the medium term.”
Not all share the concern on low inflation. “Some other” members of the Fed were more worried about “risks arising from a labor market that had already reached full employment and was projected to tighten further” or the easing of financial conditions since the Fed initiated its monetary policy normalization efforts in December 2015. Those holding that view “a delay in gradually removing policy accommodation could result in an overshooting of the Committee’s inflation objective that would likely be costly to reverse, or that a delay could lead to an intensification of financial stability risks or to other imbalances that might prove difficult to unwind.”
Regarding setting a date for balance-sheet action, those on the Fed “generally agreed” in light of their current outlook that it was “appropriate to signal that implementation of the program likely would begin relatively soon, absent significant adverse developments in the economy or in financial markets.” The reduction in monetary policy accommodation from the balance-sheet trim would likely “contribute only modestly” to a tightening of monetary policy. “Although several participants were prepared to announce a starting date for the program at the current meeting,” the minutes noted, “most preferred to defer that decision until an upcoming meeting while accumulating additional information on the economic outlook and developments potentially affecting financial markets.”
Fed staff still say inflation impacts are “transitory.”
Now the phrase, “idiosyncratic factors.” Forecast inflation at the consumer level as measured by the Personal Consumption Expenditures (PCE) price index “was revised down slightly for 2017 in response to weaker-than-expected incoming data for inflation.”
Outlook beyond 2017 was “revised little” as the staff said, “recent weakness in inflation was viewed as transitory.” But the minutes noted that, “Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors,” the minutes said, not really providing a definition of idiosyncratic factors. And they still saw PCE price inflation to be held down over the rest of 2017 “by the effects of those factors, and the monthly readings might be depressed by possible residual seasonality in measured PCE inflation.”
Fiscal policy uncertainty also noted. While consumers appeared to have continued expanding their activity, the minutes noted that businesses perhaps had pulled back their spending/investment activity due to continued policy uncertainty in Washington.
Bottom line. The CME FedWatch tool has moved to just over 55% odds for no change in rates in December, 40% for a quarter-point increase and a 2% change of a quarter-point reduction. Inflation was a point of considerable discussion, and likely led to the variant views on the Fed and thus on market expectations that appear still to favor no rate increase for the balance of the year. Regarding the Fed’s balance sheet, officials were split in July on announcing a specific date. That still is most likely to happen at the September session, barring any major development that suddenly injects something new into the equation.
