The minutes of the September 17-18 minutes did not offer up much in the way of surprises regarding the FOMC’s discussion of the economy and current monetary policy. The tone and tenor of the discussion reinforced that the Committee’s decision as based on managing risks to the expansion. These risks by-and-large were much the same as they were back at the July deliberations. However, as the minutes said, “Participants generally had become more concerned about risks associated with trade tensions and adverse developments in the geopolitical and global economic spheres. In addition, inflation pressures continued to be muted.” The minutes broke it down as, “trade tension and concerns about the global outlook as the main factors weighing on business investment, exports, and manufacturing production.”
The minutes also said, “Several participants noted that statistical models designed to gauge the probability of recession, including those based on information from the yield curve, suggested that the likelihood of a recession occurring over the medium term had increased notably in recent months. However, a couple of these participants stressed the difficulty of extracting the right signal from these probability models, especially in the current period of unusually low levels of term premiums.” The temperature of the economy and financial markets expressed here is three weeks old.
In the interim, data about conditions in manufacturing have slipped into mild contraction, and services have softened to only narrow expansion. While the labor market as a whole continues to exhibit the “strong” character of the minutes, the September Employment Situation and a few surveys of business activity suggest that job openings may have reached a plateau and workers may have less competitive advantage in commanding higher wages and/or benefits.
At meeting end “most” FOMC participants agreed to rate cut as appropriate, and “several also noted that, because monetary policy actions affected economic activity with a lag, it was appropriate to provide the requisite policy accommodation now”, i.e. take out a little insurance against future slowing in growth. Indeed, “A few participants observed that the considerations favoring easing were reinforced by the proximity of the federal funds rate to the ELB. If policymakers provided adequate accommodation while still away from the ELB, this course of action would help forestall the possibility of a prolonged ELB episode.” This was the sort of early and aggressive stance that was discussed early in the meeting in regard to the review of the Fed’s monetary policy framework.
There was clearly a divide among those wanting a 50 basis point cut in rates and those who would have preferred to wait.
The Federal Reserve is still the process of holding “Fed Listens” events to communicate its challenges and open up the review to all stakeholders. Nothing has been finalized as yet, but a few points seem to be nearing a consensus:
- With short-term rates close to the Effective Lower Bound (ELB) and the neutral rate hard to determine exactly, but certainly lower than in the past, the central bank has less room to provide accommodation through cutting rates. As such, alternate tools are more likely to be needed and used. To avoid getting stuck near the ELB for too long, the Fed can mitigate risks by “using forward guidance and balance sheet policy earlier and more aggressively than in the past.”
- There is a focus on how best to balance the dual mandate, particularly in regard to ensuring that inflation is sustainably near target. The exploration of make up strategies in regard to price stability “depend importantly on the private sector’s understanding of these strategies.” The challenges seem to be in ensuring markets understand and believe in the Fed’s commitments, accurately communicating what the mechanism to make up for low inflation is and how it will work, maintaining flexibility in policy versus being tied to rules to implement the strategy, and if those rules limit the appropriate policy response when inflation above 2% “amid signs of an impending economic downturn.”
- I continue to think that the Fed will eventually opt for the alternative put forward by “several participants” who suggested “that the adoption of a target range for inflation could be helpful in achieving the Committee’s objective of 2%” – possibly with a mid-point above 2% — as a “threshold-based forward guidance” for inflation.
There wasn’t much in the minutes about the cash crunch that led the New York Fed into holding some overnight repo operations that has since evolved into a two-month program of overnight and term repurchase operations.
The minutes said, “money markets became highly volatile just before the September meeting, apparently spurred partly by large corporate tax payments and Treasury settlements, and remained so through the time of the meeting. In an environment of greater perceived uncertainty about potential outflows related to the corporate tax payment date, typical lenders in money markets were less willing to accommodate increased dealer demand for funding. Moreover, some banks maintained reserve levels significantly above those reported in the Senior Financial Officer Survey about their lowest comfortable level of reserves rather than lend in repo markets. Money market mutual funds reportedly also held back some liquidity in order to cushion against potential outflows. Rates on overnight Treasury repurchase agreements rose to over 5 percent on September 16 and above 8 percent on September 17.”
This brought a new item to the table for discussion, the “appropriate level of reserve balances sufficient to support efficient and effective implement of monetary policy in the context of the ample-reserve regime.” The possibility that the balance sheet would have to grow again was noted, but also that that growth “should be clearly distinguished from past large-scale asset purchase programs that were aimed at altering the size and composition of the Federal Reserve’s asset holdings in order to provide monetary policy accommodation and ease overall financial conditions.” “Several” participants brought up the possibility of a “standing repurchase agreement facility as part of the framework for implementing monetary policy.” This latter idea seems to have gotten a de facto implementation with the New York Fed’s October 4 announcement that it was extending its overnight repo operations through Monday, November 4. In any case, the prudence and/or necessity of such a facility will get a thorough discussion at the October 29-30 meeting.
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