Jan. FOMC Minutes: Increased Uncertainty Over Global Developments, Inflation

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Uncertainty on the Federal Open Market Committee (FOMC) was very evident as they met January 26-27 in Washington, with concerns over foreign developments, a continued lack of progress toward the Fed’s 2% goal for inflation and a slowing US economy at the end of 2015 all key points discussed at length, according to minutes of the session. Link.

“While participants continued to expect that gradual adjustments in the stance of monetary policy would be appropriate,” the minutes said, “they emphasized that the timing and pace of adjustments will depend on future economic and financial market developments and their implications for the medium-term economic outlook.”

Heavy focus on foreign developments: The slowdown in China’s industrial sector and decline in global commodity prices “could restrain economic activity in the EMEs [emerging market economies] and other commodity-producing countries for some time.” Discussions on China included the prospect that “structural changes and financial imbalances in the Chinese economy might lead to a sharper deceleration in economic growth in that country than was generally anticipated. Such a downshift, if it occurred, could increase the economic and financial stresses on other EMEs and on commodity producers, including Canada and Mexico.” Further, the minutes indicated that FOMC members noted “global financial markets could continue to be affected by uncertainty about China’s exchange rate regime.”

While the direct linkages with the US and China’s economy are “limited,” the minutes said, “a number of participants were concerned about the potential drag on the US economy from the broader effects of a greater-than-expected slowdown in China and other EMEs.”

Foreign developments & financial market turbulence: FOMC members noted “several apparent factors underlying the recent financial market turbulence, including economic and financial developments in China and other foreign countries, spillovers in financial markets from stresses at firms and in countries that are producers of energy and other commodities, and an increase in concerns among market participants regarding the prospects for domestic economic growth.” However, “a number of participants” indicated the “large magnitude of changes in domestic financial market conditions was difficult to reconcile with incoming information on U.S. economic developments.” While “a couple” noted the recent equity market swoon could be bringing equity valuations “more in line with historical norms” while a “few” participants warned that commercial real estate (CRE) markets should be “closely monitored.”

Staff observations on global market conditions: Those conditions “deteriorated sharply in January, as recent developments in Chinese financial markets and the further decrease in crude oil prices appeared to increase concerns about global economic growth.” The staff also indicated that market expectations for foreign central bank policy rates had risen some after the December FOMC meeting but had “ended the period lower.” Further, the staff indicated, “The foreign exchange value of the U.S. dollar appreciated further against most currencies, with larger increases relative to the currencies of commodity-exporting countries.”

Oil & commodity price declines and dollar appreciation: Further oil and commodity price declines and rise in the US dollar, in the view of meeting participants, “would keep inflation low in the near term” but there were still a “range of views on the effects on the medium-term outlook and the risks attending the outlook.” Expectations remain that once commodity prices and the value of the US dollar stabilize, “the effects of those factors on inflation would fade. Several saw that outlook as depending importantly on continued strengthening of the labor market or on an above-trend pace of economic activity. Moreover, some emphasized the need for longer-run inflation expectations to remain well anchored.”

Inflation challenges remain: While some indicated survey-based inflation measures and market-based measures of inflation compensation signaled “long-term inflation expectations were still relatively well anchored, some others expressed concern about the further decline in inflation compensation recently and the historically low levels of some survey measures of longer-run inflation expectations.” While “most” FOMC members still expected inflation would rise to the Fed’s 2% objective over the medium term, “a number of participants indicated that, in light of recent developments, they viewed the outlook for inflation as somewhat more uncertain or saw the risks as being to the downside.”

To increase the Fed funds rate range or not: The minutes revealed FOMC members discussed whether the situation relative to economic conditions “warranted either increasing the target range for the federal funds rate at this meeting or altering their earlier views of the appropriate path for the target range for the federal funds rate.” Noting that labor market data had been “encouraging,” but “data releases since the December meeting on spending and production had been disappointing.” Commodity and financial market developments and potential weakening in foreign economies “had the potential to further restrain domestic economic activity, partly because the large cumulative declines in energy and other commodity prices could have pronounced adverse effects on some firms and countries that are important producers of such commodities,” the minutes said, while a “few” viewed the potential boost from lower energy prices could mitigate those impacts. “Participants judged that the overall implication of these developments for the outlook for domestic economic activity was unclear, but they agreed that uncertainty had increased, and many saw these developments as increasing the downside risks to the outlook,” the minutes said.

The 2% inflation goal remains key: “Most participants still expected inflation to increase gradually once energy prices and the prices of non-energy imports stabilized and as the labor market strengthened further. However, a few participants noted that direct evidence that inflation was rising toward 2% would be an important element of their assessment of the outlook and of the appropriate path for policy.”

Uncertainty viewed by some as increasing downside risk: “Most participants indicated that it was difficult to judge at this point whether the outlook for inflation and economic growth had changed materially, but they thought that uncertainty surrounding the outlook had increased as a result of recent financial and economic developments,” the minutes said. Further, they noted that “most participants were of the view that there was not yet enough evidence to indicate whether the balance of risks to the medium-term outlook had changed materially, but others judged that recent developments had increased the level of downside risks or that the risks were no longer balanced.”

Waiting to raise rates ‘prudent:' “Several participants” took the view that “monetary policy was less well positioned to respond effectively to shocks that reduce inflation or real activity than to upside shocks, and that waiting for additional information regarding the underlying strength of economic activity and prospects for inflation before taking the next step to reduce policy accommodation would be prudent.”

Gradual and data driven: While FOMC members still expected to make “gradual” adjustments in monetary policy and that such a path would be “appropriate,” the minutes noted, “they emphasized that the timing and pace of adjustments will depend on future economic and financial market developments and their implications for the medium-term economic outlook.” Further, Fed officials agreed to continue to highlight that future decisions on monetary policy would be data-driven.

Comments: Concern and uncertainty are prevalent throughout the minutes of the January session. And, as Fed Chair Janet Yellen observed in her congressional testimony last week, conditions changed since the Fed met in December. While still expecting that inflation will move toward their 2% goal, it’s clear that the downturn in energy prices combined with strength in the dollar were concern points. And the global focus was significant at the January meeting, something that became public in appearances by Fed officials in the wake of the Jan. meeting leading up to Yellen’s testimony to Congress. This is a Fed that is now uneasy after their December rate rise. And that unease relative to the foreign side of the equation appears elevated even from what some Fed officials have indicated in their comments since the January meeting. This certainly backs up the expectation that a rate rise is not going to be in the cards in March and potentially even for several months beyond that.

Often times, uncertainty translates into doing nothing. If that is the case and conditions now are still similar when the March 15-16 meeting arrives, no policy moves may well be made. The debate more than likely as the March meeting gets closer and closer is whether the Fed will hold policy steady or potentially even back track and lower rates. But seemingly for that to happen, it would take another downshift in economic data as the meeting arrives. So far, we’ve not seen probably enough deterioration to prompt a rate decrease. But that may not stop that type of discussion from unfolding.

If the Fed does stand pat on policy and Fed officials downgrade their outlooks on inflation and GDP, Fed Chair Yellen will no doubt use much of her post-meeting press conference sounding more like she did on the Hill last week. And while the data-driven caveat will still be the default view, caution is now seemingly overtaking the Fed.

NOTE: This column is copyrighted material; therefore reproduction or retransmission is prohibited under U.S. copyright laws.