Having been abused by President Trump and seen bonds and stocks rally, the dollar round-trip to unch, and the yield curve crash, today’s FOMC Minutes were not expected to be big market movers, but more reassurance that investors should ignore the collapsing yield curve and President Trump.
For now the FOMC appears set on hiking rates and shrinking the balance sheet no matter what:
“Many participants suggested that if incoming data continued to support their current economic outlook, it would likely soon be appropriate to take another step in removing policy accommodation.”
“Participants generally expected that further gradual increases in the target range for the federal funds rate would be consistent with a sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term.”
“A couple of participants commented on issues related to the operating framework for the implementation of monetary policy, including, among other things, the implications of changes in financial market regulations for the demand for reserves and for the size and composition of the Federal Reserve’s balance sheet.”
As the Fed gradually raises its benchmark rate, describing interest-rate policy as accommodative will “at some point fairly soon … no longer be appropriate,” the minutes said. One reason to dial back this guidance is that it could “convey a false sense of precision,” the minutes said, particularly in an environment where the Fed has dramatically expanded its bond portfolio and where fiscal stimulus has been increasing.
In other words, the “remains accommodative” text will soon be dropped from the Fed statement.
Separately the minutes provided few clues about how much longer Fed officials believe they’ll need to raise interest rates. They noted familiar debates about whether or why wages would soon pick up. Some officials believed inflation would move above the Fed’s 2% objective for a while, but others pointed to inflation expectations that would remain below levels consistent with the target.
The minutes said a few officials had grown more confident that the Fed would sustain 2% inflation. Several officials reported businesses “had greater scope than in the recent past to raise prices in response to strong demand or increases in input costs,” including from tariffs or higher fuel and freight prices.
Some officials continued to raise concerns that the economy would overheat, giving way to higher inflation or financial imbalances that would result in a recession.
The Minutes also noted the downside risks in the market, noting that the ongoing trade disagreement and proposed trade measures are important source of uncertainty, cautioning that any large-scale and prolonged trade dispute would likely have an adverse impact on business sentiment, investment and employment. As a result, the escalation of trade disputes was potentially a consequential downside risk for the US economy.
On the downside, trade policies could move in a direction that would have significant negative effects on economic growth. Another possibility was that recent fiscal policy actions could produce less of a boost to aggregate demand than assumed in the baseline projection, as the current tightness of resource utilization may result in smaller multiplier effects than would be typical at other points in the business cycle.
Participants observed that if a large-scale and prolonged dispute over trade policies developed, there would likely be adverse effects on business sentiment, investment spending, and employment. Moreover, wide-ranging tariff increases would also reduce the purchasing power of U.S. households.
Meanwhile, the Fed noted the capacity for higher wage growth…
“Reports from several Districts suggested that firms had greater scope than in the recent past to raise prices in response to strong demand or increases in input costs, including those associated with tariff increases and recent rises in fuel and freight expenses.”
… and as Bloomberg’s Tim Mahedy notes, FOMC members acknowledged that “tepid wage growth is a sign of economic slack, perhaps as Doves are laying the groundwork for a December showdown.”
The FOMC also touched on the collapse of the Phillips curve:
… some participants observed that inflation in recent years had shown only a weak connection to measures of resource pressures
And while they were not especially vocal, “several” participants raised concerns about the collapsing yield curve:
“Participants also discussed the possible implications of a flattening in the term structure of market interest rates…. Several participants cited statistical evidence for the United States that inversions of the yield curve have often preceded recessions.”
“They suggested that policy-makers should pay close attention to the slope of the yield curve in assessing the economic and policy outlook.”
The message here is that no consensus exists yet as to how to incorporate this information into making policy decisions.
And an interesting observation from Bloomberg’s Ira Jersey:
The Fed acknowledged it might have to lower rates in the future to the “ELB” or effective lower bound of interest rates.
“In this new world (or is it going back to the pre-1960s world?), the committee doesn’t seem keen on doing a lot more QE the next time around.
“So the question becomes what other tools within their monetary policy mandate can they come up with. Look for more on the `prudent planning’ of `alternative policy strategies’ in the future. Maybe they won’t be needed, but then again….”
And the usual warning on elevated valuations:
Participants who commented on financial stability noted that asset valuations remained elevated and corporate borrowing terms remained easy.
The dollar dipped on the news, and after a kneejerk reaction higher, bonds and stocks have regained previous levels.
Furthermore, since the August 1st FOMC statement, the US yield curve has crashed back to 11 year lows at just 21bps.
The market remains far distant from the reality that The Fed perceives in rates – in fact pricing in rate cuts in 2020, as opposed to rate-hikes as per The Fed…
Bloomberg additionally notes that The Fed has been nudging inflation-adjusted rates closer to neutral:
* * *
Full Minutes below:
Finally we note that today’s FOMC meeting Minutes will have a short shelf life, as market participants will quickly refocus on the Fed’s Jackson Hole conference later in the week.