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Comment: FOMC meeting minutes from March 19-20 indicate inflation pivotal to next rate decision, but patience will prevail for now

The minutes of the March 19-20 FOMC meeting did not provide a lot of fresh detail to fill out the available information present in the already-published meeting statement, Balance Sheet Normalization Principles and Plans, projections materials, or the Chair’s press briefing. The minutes were in fact a bit of out date regarding economic conditions. In the three weeks since the FOMC met, the March employment data showed that February’s scant job adds were a one-off, and with the backlog of economic data reports from the government shutdown have indicated that the first quarter is starting to pick up again as it finds it footing after the slowdown in late 2018.

There was a more in-depth picture of the discussions around the best approach to bringing the balance sheet normalization to a conclusion. There were two options on the table: to taper the cap on Treasury redemptions and leave the balance sheet slightly larger when discontinued in September, or to continue redemptions at the current pace. However, the minutes concluded that over time, “Staff projections of term premiums and macroeconomic outcomes did not differ substantially across the two options.” Opting for the former was a little more complex to communicate but had the advantage of providing some room and time to determine the best level of reserves to maintain to keep market volatility to a minimum. The minutes said, “Participants judged that ending the runoff of securities holdings at the end of September would reduce uncertainty about the Federal Reserve’s plans for its securities holdings and would be consistent with the Committee’s decision at its January 2019 meeting to continue implementing monetary policy in a regime of ample reserves.”

The approximate size and composition of Treasurys in the balance sheet was not determined. In his press briefing, Chair Powell mentioned the balance in September is likely to be somewhat above $3.5 trillion. However, future reinvestments would be “allocated across sectors of the Treasury market roughly in proportion to the maturity composition of Treasury securities outstanding.”

Chair Jerome Powell “proposed that the Committee communicate its intentions regarding balance sheet normalization by publishing a statement at the conclusion of the meeting. All participants agreed that it was appropriate to issue the proposed statement.” The decision likely reflected a desire to ensure that markets had plenty of time to fully understand the Fed’s intentions.

As noted above, the review of economic conditions in the meeting reflected three weeks ago. However, the basic conclusions about the economy remains sound. The minutes said, “Participants continued to view a sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes over the next few years.”

The minutes said, “[M]ost participants indicated that they did not expect the recent weakness in spending to persist beyond the first quarter. Nevertheless, participants generally expected the growth rate of real GDP this year to step down from the pace seen over 2018 to a rate at or modestly above their estimates of longer-run growth.” The economic data released during the past three weeks is consistent with that expectation. The advance report on first quarter GDP will be released at 8:30 ET on Friday, April 26. The FOMC will have it in hand when they meet on April 30-May 1.

The FOMC’s forecasts were for slower growth in 2019. The minutes noted, “Participants cited various factors as likely to contribute to the step-down, including slower foreign growth and waning effects of fiscal stimulus.”

Regarding downside risks to growth, the minutes said, “A few participants noted that there remained a high level of uncertainty associated with international developments, including ongoing trade talks and Brexit deliberations, al­though a couple of participants remarked that the risks of adverse outcomes were somewhat lower than in January.” At this writing, these are still unresolved.

The minutes continued, “Other downside risks included the possibility of sizable spillovers from a greater-than-expected economic slowdown in Europe and China, persistence of the softness in spending, or a sharp falloff in fiscal stimulus. A few participants observed that an economic deterioration in the United States, if it occurred, might be amplified by significant debt service burdens for many firms.” Recent data from Europe and China will mean that this remains a concern.

Conversely, more favorable outcomes in Europe and China, and a positive resolution to trade talks could mean economic growth is firmer than presently anticipated.

“Most participants, while seeing inflation pressures as muted, expected the overall rate of inflation to firm somewhat and to be at or near the Committee’s longer-run objective of 2 percent over the next few years,” the minutes said. It was noted that an upside risk for inflation is that “wage pressures could rise unexpectedly and lead to greater-than-expected price increases.” However, at present inflation at the core level remains consistent with the 2% objective.

There was a discussion of “alternative interpretations of subdued inflation pressures in current economic circumstances and the associated policy implications.”

“Several participants observed that limited inflationary pressures during a period of historically low unemployment could be a sign that low inflation expectations were exerting downward pressure on inflation relative to the Committee’s 2 percent inflation target,” the minutes said. Also, with a strong labor market, the “appropriate response” of monetary policy “could be modest provided that signs of inflation pressures continued to be limited.” This would suggest that as long as inflation hovers near the 2% objective, the Committee will be comfortable in keeping interest rates on hold.

“A few participants cited the combination of muted inflation pressures and expanding employment as a possible indication that some slack remained in the labor market,” the minutes said. However, this is a minority view. Anecdotal evidence and regional surveys for manufacturing and services suggest that there is a scarcity of workers with suitable job skills. Jobs are remaining open in part because of the difficulty in filling them.

There was a clear consensus among policymakers that remaining “patient” regarding further interest rate hike was appropriate at this time. “Several” thought the current fed funds target rate range is near the longer-run neutral level. It is likely the remainder see it as not far below. However, all participants agreed that future policy decisions “would depend on their ongoing assessments of the economic outlook.”

“Several” participants left open that “the federal funds rate could shift in either direction based on incoming data and other developments”. On the other hand, “Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year.” Among the former, there was a signal that should the economy weaken, they were prepared to provide support via lower interest rates. Among the latter there was more confidence that their forecast for growth in 2018 would mean removing a little more interest rate accommodation. In any case, it was reiterated that the Summary of Economic Projections (SEP) is not a pledge that monetary policy is on a “preset course”.

In the end, the FOMC determined, “With regard to the outlook for monetary policy beyond this meeting, a majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year.”

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