Perhaps the biggest surprise in the release this afternoon of the Minutes to the Federal Open Market Committee on July 31-August 1 was what was not in there: we had kind of assumed there would be a long discussion at the meeting, complete with staff presentations, about the various options and issues in deciding on the eventual operating framework and optimal size of the balance sheet.
So as a first takeaway from the Minutes, it would seem when Chairman Jerome Powell said in his testimony on Capitol Hill last month that the FOMC would be taking up the matter “fairly soon,” he was thinking in terms of months not weeks. As the Minutes note, “the Chairman suggested that the Committee would likely resume a discussion of operating frameworks in the fall.” We would take that to mean the November meeting, since the September meeting agenda may be pretty full.
Turning to September, beyond that no-show in the Minutes, we had a Magnificent Seven takeaways from our first reading of the Minutes in foreshadowing the likely policy path in the near term:
First, in noting that if the data is there as expected, “it would likely soon be appropriate to take another step in removing policy accommodation…[and that] participants generally expected that further gradual increases,” the FOMC telegraphed a near certain rate hike in September, which could be expected but that, more likely than not, the Committee is also assuming they will be pressing ahead with “further” gradual increases beyond September.
The debate beyond September then, is going to be surrounding the probing for just where neutral lies, and how soon the Fed will safely be able to pause in the pace of the rate hikes (see SGH 8/20/18, “Fed: Jackson Hole, For Now”).
Second, we were a bit surprised the FOMC was so explicit in noting their intentions to jettison the “accommodative” sentence since it would no longer be so appropriate “fairly soon,” which we would take to mean after a September rate hike. The Committee also seems to want to get rid of it altogether rather than a partial shift away with a “still” or “fairly” accommodative qualifier.
That option, it would seem, would have been too much like splitting hairs on an estimate that, after all, is utterly unobservable and has a fairly wide band of uncertainty around it “continuing to provide an explicit assessment of the federal funds rate relative to its neutral level could convey a false sense of precision.” So better to dump the sentence altogether sooner rather than later with the next rate hike and be done with it.
It may, however, raise some potentially difficult messaging complications at the September meeting, in that the market may interpret its removal as a dovish signal the rate trajectory is drawing to its close; and the Committee will have to sort out how it will fit in the overall messaging mix if the September rate dot plot still shows two hikes in 2018, or the rate trajectory extending into 2021. Jackson Hole and the weeks in the run up to the September meeting may provide some clues on the messaging work that lies ahead.
Third, the FOMC majority looks to be taking the yield curve inversion debate with a huge grain of salt. Maybe an inversion would indeed portend a recession, as “several participants apparently argued in the meeting, and in public over recent weeks,” but a seeming majority think that “inferring economic causality from statistical correlations was not appropriate” and furthermore, that “the signal to be taken from the yield curve needed to be considered in the context of other economic and financial indicators.”
For now, color the Committee skeptical on the yield curve inversion risk; but let’s see how confident they are later this fall if it is indeed looks to be underway.
Fourth, when it came to the outlook for wages and inflation, the Committee noted that wage growth is lackluster at best, and may still indicate slack in the labor market, but they also expressed their confidence that they will pick up before too terribly long, if for any other reason, firms were changing their attitudes about tossing in some wage increases.
And fifth, inflation, while still pretty inertial, could also be picking up in the near term due to a change in conditions and firm psychology making them more willing and able to raise prices.
The sixth takeaway is all about the ongoing debate over the trade effects, nothing much to note so far but it may delay investment spending. Perhaps more to the point, the trade effects are going to be a pain in factoring into the monetary policy reaction function.
Seventh, last but not least, we thought perhaps one of the more interesting points to be taken from the Minutes, the Committee noted the fiscal stimulus entailed an obvious upside risk, but less obviously, at least some Committee members argued the assumed fading of its effects on demand may entail some downside risk, especially if it hits at the same time of the eventual trade drag effects on growth.
It will be worth watching to see whether that is indeed a viable scenario that will weigh on the policy calculations going into the new year. Or, for that matter, if by next year, there isn’t any fade at all in the fiscal stimulus, that would entail one large change in the forecast and the Fed’s reaction function, all of it to upside risk.