Two takeaways on yesterday’s release of the September Federal Open Market Committee meeting Minutes:
Misreading the Minutes on the dollar and low inflation
First, we believe the market and media are way over-reading into the mentions here and there in the Minutes of the effects of the stronger dollar or concerns over the pace of growth and inflation. It was by all accounts unusual for the dollar to come up so explicitly in the meeting discussions, and several of the more dovish-leaning Committee members made note of the dollar impact in subsequent speeches.
But as we noted last week (SGH 10/3/14, “Fed: A “Patient” Reaction Function”), most of this early “raised-eyebrow” commentary is aimed at blunting the upcoming push by their more hawkish colleagues to make the case for a first rate hike in the first four months or so next year. It is not to argue that the Fed will not be able to raise rates next year — which we still believe the majority of the FOMC is penciling in for June, depending, as always, on how closely the data hues to the central tendency forecast — and certainly not to make a case for reversing course on QE and extending the remaining bond purchases beyond the end of this month.
We do not want to stand in front of a runaway train rally in the fixed income pricing since yesterday afternoon, but things are just not looking that grim out there in the world of the real economy. We indeed wonder how much of the uber-dovish interpretation — of what we believe were fairly balanced Minutes only modestly leaning dovish at the end of the day — is being driven by post hoc rationalization of the current market zeitgeist being read into a policy discussions that took place three weeks ago.
And as we wrote last week, the slippage in the inflation measures is most clearly raising eyebrows among the FOMC doves who thought or had hoped the persistence in low inflation around the 1% mark up through last spring was behind them. But that said, the forecasting assumptions are still for inflation to move in a sticky sideways trend in the near term rather than be pushed ever lower by the strong dollar or ever lower to European or Japanese deflation levels.
And we would add not to take the modest decline in market inflation expectations too seriously: the Fed is much more concerned with any persistent change in real economy inflation expectations, not the far more fickle market expectations.
All else being equal then — a dangerous caveat to be sure — low inflation will not be in itself be enough to derail or deeply postpone a first rate hike unless layered on top is a serious stall in the pace of the recovery.
But what the inflation reading translates into for now is some more running room to wait for higher wages to finally show up as the headline unemployment rate is brought through any notion of NAIRU. And that adds to the weight of an ever gradual pace in the eventual rate tightening, not necessarily to put off a first rate hike until, well, forever.
Considerable Time Still in Play
Second, the Minutes did surprise us on how non-committal the Committee members were on changing the “considerable time” language of the forward guidance. If the consensus was at least a bit firmer that it would be coming out in the October statement, we would have thought there would have been more of a lean in that direction in the Minutes. But it would seem the Committee is punting on the question.
Several of the dovish Committee members cautioned in speeches since then against the risk of mis-interpreting any change as an unintended hawkish signal, just as the Minutes underscored, but they also went out of their way to urge “patience” on the timing to a rate hike and to changes in the guidance.
Our sense is still that the considerable time phrasing will be past its sell-by date when the bond purchases are brought to a close at the end of this month — again we do think it is highly unlikely the bond purchases will be extended beyond Halloween unless the labor market makes a turn for the worse — and so the October statement for a majority of the FOMC is the most natural, and easiest moment to move on to a new guidance language.
We suspect “patience” in removing monetary accommodation until the economy is closer to mandate-consistent levels of employment and inflation is the most obvious new language of choice. But it still begs the question of the Fed’s reaction function to the incoming data, that is, how close is “close enough?”
In other words, the guidance debate is still very much a work in progress, more so than we would have thought at this point. It is hard not to notice the discomfort in the Minutes in the point made about risk management considerations that “suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the Committee’s goals.”
So while our sense remains that the loaded considerable phrasing is coming out, it does rather sound like another punt is a real option. And that may, in turn, mean the considerable phrasing remains by default rather than design until the December meeting, but which in any case, would almost certainly neuter its policy signaling significance even more than it has been already.