With just hours before the Minutes to the September 16-17 meeting of the Federal Open Market Committee are released later this afternoon, we think the Minutes may come off as a bit hawkish relative to where market sentiment is now, some three weeks later when a first rate hike feels like it is priced in for another lifetime.
*** We do think it was a close-call decision in September to hold off on a first rate hike and that while the reasons to wait were dovish by definition, it was a hawkish decision in that it was more tactical than strategic in the sense of no regime shift or change in the reaction function. ***
*** Looking forward, if the coming data lend support to the case the labor market is still tightening despite the slowing net job creation, or that global growth is only slowing but steering clear of a hard landing, an FOMC majority will still want to start policy normalization at its December meeting. ***
Hawkish Takeaways from Dovish Debate
We certainly expect there will be all sorts of dovish takeaways throughout the Minutes, but we equally think nearly all of the same dovish points raised will tilt towards a more neutral or hawkish conclusion that will underscore how closely debated and tactical the rate decision was in the end.
There will be lengthy discussions among the FOMC “participants” of the risks to the international growth outlook, for instance, but the policy section near the end of the Minutes is still more likely to show a large majority of the (voting) “members” discounting the probabilities the slower growth would translate into a large enough hard landing shock to push US growth below trend next year.
In that sense, the inclusion of the “new” information sentence in the statement that “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term” was not a signal to a new reaction function, but was meant instead to be simply stating the obvious risk.
Indeed, for all the handwringing likely to show up over the international outlook, the inevitable debate over the pace of job growth, or the angst over the persistence in the low inflation, it would seem the narrow central tendency forecasts of the accompanying Summary of Economic Projections did not really change all that much from the June projections.
So we will be curious to see whether the confidence bands widened around the narrow forecasts that would help explain the caution tipping the decision to hold off on a rate hike.
And while the more dovish Committee members will point to the absence of wage growth to argue NAIRU is even lower than the 5.1% median Committee estimates, we don’t have the sense that a majority of the Committee members or staff were expecting a noteworthy quickening in wage growth just yet anyway or were all that surprised by its absence by the time of the September meeting.
We also suspect in the discussions on the labor market that many members were putting an accent on the “cumulative” gains in the utilization of labor market resources, and perhaps even the expectation that the pace of job growth will probably slow later this year. And as last week’s Nonfarm Payroll and downward revisions of the previous two months revealed, that in fact was already underway.
It would explain why some Committee members are already stressing how a 100,000 or more in net monthly new jobs from here would still be removing labor market slack when the headline unemployment rate is so near the assumed longer run levels or NAIRU (see SGH 10/5/15, “Fed: The NFP and Its Aftermath”).
And the discussion sections will probably likewise record at some length the debate over the risks in the persistence of low inflation, and how long it will be before the diminished slack in the labor market translates into higher broad-based wage growth or higher core inflation.
But we also expect a fairly robust defense of the Phillips Curve assumptions that the increasing labor market tightness will in time underpin a rise in core inflation that may nevertheless drift modestly lower before moving higher. There may have in fact been some debate over whether to make that point explicitly in the statement.
Prudence in Passing on a Rate Move
In the end, though, we think the Minutes will convey in some fashion that the decision against a first rate hike at the September meeting was driven primarily by a deference to Chair Janet Yellen, who we think probably opted for prudence and a pass on a rate hike on two key fronts: a risk management caution to wait for clarity on whether there was an accelerating weakness in global growth, and more time to reset messaging by stressing how policy normalization will still keep conditions highly accommodative for some time (see SGH 9/24/15, “Fed: Yellen on Inflation”).
The more dovish Committee members are likely to have pressed their case that a first rate hike as soon as September could risk coming at exactly the wrong time, just before a possible downside shock to global growth that would be reaching into the US growth outlook by early next year.
Because it would be costly to offset, that risk would outweigh any risk in waiting another month or three months for starting a policy normalization which, after all, is expected to stretch across the better part of three plus years. It would be better to prudently wait just a bit longer.
And we suspect the Minutes will underscore that it wasn’t the volatility across the markets per se that caused the FOMC to hold off – volatility is expected and to some degree welcomed if it reflects greater price discovery – but rather it was what the volatility may have been suggesting about an underlying weakness in the global growth that raised so many flags of caution for many FOMC members.
If that proves to be the case, the Minutes may also include a discussion on how much the Committee can expect, or need to see, a further alignment in market pricing to the Fed’s most likely near policy path before moving forward with a start to policy normalization.
And related to that, we will be curious to see whether the debate over the risks to financial stability picked up from their July meeting discussions as a reason to move off the Zero Lower Bound.
And finally, one last point to make at the risk of stating the obvious: the Minutes are meant to accurately reflect a summary of the staff presentations and forecasts, the key points raised in the discussions by the FOMC participants, and to convey what the voting “members” weighed and decided before the wording of the statement was finalized.
But contrary to a view in some quarters of the market, they are not intended or written to provide a new “signal” on the likely policy path going forward or tailored to “correct” a mistaken market interpretation of the statement or post-meeting press conference. Ultimately, the dovish or hawkish reaction to the Minutes are in the eyes of the Beholder.