The FOMC meeting minutes from April 30-May 1 were cautious on the outlook for inflation and inflation expectations, and the consensus was clearly prepared to wait and see if the risks to the economy cooled or heated up in coming week. While markets may have been hoping for a distinctly dovish tone to the discussion, it was not there. The minutes reflected a Committee that had plenty of solid economic data for the labor market, some short-term blips in price stability, and only modest financial market stresses relative to overall conditions.
Of course, at this writing the minutes are three weeks old and to some extent have been overtaken by events. Things may be clearer by the time of the June 18-19 meeting when the FOMC will update its collective forecast. Comments in the weeks since the April 30-May 1 meeting suggest that overall policymakers are on pause. One or two may regret some of the removal of accommodation that was undertaken last year, but the consensus remains firmly in line with these as appropriate policy actions then.
In its outlook for the economy, the minutes said, “Participants continued to view sustained expansion of economic activity, with strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective as the most likely outcomes.” They noted that the composition of strong first quarter GDP was such that it suggested growth would moderate in 2019 from 2018.
On the plus side, the economy is expected to growth due to “continuing strength in labor market conditions, improvements in consumer confidence and in financial conditions, or diminished downside risks both domestically and abroad, as factors likely to support solid growth over the remainder of the year.” Risks to financial markets “had improved following the period of stress observed over the fourth quarter of last year and that the volatility in prices and financial conditions had subsided.” However, the FOMC noted some of the issues highlight in the May 2019 Financial Stability Report about concerns related to nonfinancial corporate indebtedness. “A couple of participants” also mentioned that “asset valuations in some markets appeared high, relative to fundamentals.”
On the downside was further fading in the stimulus from fiscal policy and the effect of less accommodative monetary policy. “Prospects for a sharp slowdown in global economic growth” were said to have diminished. However, this was three weeks ago and before the White House announced fresh tariffs and restrictions on technology exports. At the time of the meeting, “A number of participants observed that some of the risks and uncertainties that had surrounded their outlooks earlier in the year had moderated, including those related to the global economic outlook, Brexit, and trade negotiations. That said, these and other sources of uncertainty remained.”
Downside risks to inflation may have increased, but on the whole participants thought recent lower readings in the PCE deflator were due to transitory, acyclical factors that would fade over time. On the other hand, the labor market data was strong and showing little or no sign of easing.
The minutes said, “Participants noted that even if global economic and financial conditions continued to improve, a patient approach would likely remain warranted, especially in an environment of continued moderate economic growth and muted inflation pressures.” This suggests that the FOMC is unlikely to raise rates again this year and should not excite hopes of a rate cut to move things along at a faster clip. The behavior of inflation seems to be the pivotal issue at the moment. “A few” FOMC participants held out the possibility to growth will be such that another rate hike if growth remained on its present track and/or that “the Committee would need to be attentive to the possibility that inflation pressures could build quickly in an environment of tight resource utilization”. Measures of inflation expectations were at a range low at the time of the meeting and “Several participants commented that if inflation did not show signs of moving up over coming quarters, there was a risk that inflation expectations could become anchored at levels below those consistent with the Committee’s symmetric 2 percent objective — a development that could make it more difficult to achieve the 2 percent inflation objective on a sustainable basis over the longer run”.
Now that the FOMC has determined to stick with “abundant reserves” and an administered rate, discussions continue as to the right size and composition of the Fed’s holdings of Treasurys and Agency MBS. The April 30-May 1 deliberations considered the maturity structure of the holdings and whether the approach to normalization should lean toward a “proportional” portfolio that is similar to that of outstanding Treasury securities, or a “shorter maturity” portfolio that would hold debt below the average maturity of debt outstanding.
For the former, the advance discussion seem to favor the proportional approach as “participants observed that moving to this target SOMA composition would not be expected to have much effect on” term premiums and “thus would likely not reduce the scope for lowering” the fed funds target range “in response to economic shocks. “As a result, several participants judged the proportional target composition to be well aligned with the Committee’s previous statements that changes in the target range for the federal funds rate are the primary means by which the Committee adjusts the stance of monetary policy.”
This approach was not without risks in that it could lead to a “relatively flat yield curve, which could result in greater incentives for ‘reach for yield’ behavior in the financial system.”
For the latter, the staff projections pointed to “increased capacity” to conduct a Maturity Extension Program (MEP) “which could be helpful in providing policy accommodation in a future economic down turn given the secular decline in neutral real interest rates and the associated reduced scope for lowering the federal funds rate in response to negative economic shocks.” “significant upward pressure on term premiums” and “imply that the path of the federal funds rate would need to be correspondingly lower to achieve the same macroeconomic outcomes as in the baseline outlook.”
While a MEP remains in the Fed’s toolbox for conducting monetary policy – as do large scale asset purchases – the original MEP that ran from September 2011 to June 2012 was viewed with some skepticism as to whether it achieved the desired result. The minutes reflected mixed opinions about using one in the future. “Some participants” “raised questions” about its effectiveness. If the FOMC had to turn to unconventional monetary policy tools, “they likely would prefer to employ forward guidance or large-scale purchases of assets.”
The FOMC reached no conclusions. The minutes said, “a decision regarding the long-run composition of the portfolio would not need to be made for some time”. Additionally, the Fed is in the process of reviewing its monetary policy strategies and tools, and the balance sheet management should be reviewed within that broader discussion.
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