The minutes of the July FOMC meeting were released yesterday, and the Greenback tanked across the board as a result. And if you’re wondering what the heck is up with that, or if you just want a quick rundown on the key takeaways that you should remember from the July FOMC minutes, then today’s write-up is just for you.
1. Fed divided on inflation outlook
In my Key Highlights from the July FOMC Statement, I mentioned that the Fed sounded a bit more downbeat on inflation.
And, well, the minutes revealed that “most” FOMC members still “expected inflation to pick up over the next couple of years … and to stabilize around the Committee’s 2 percent objective over the medium term” because “Many participants” think that the recent weakness in inflation “probably reflected idiosyncratic factors.”
However, there was this very noteworthy bit:
“Many participants … saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside.”
And remember, the Fed already downgraded its inflation forecasts during the June FOMC statement.
2. Fed worried about inflation expectations
If you can still recall, I noted in my write-up on the June FOMC statement that Fed Chair Yellen was challenged by a journalist to explain the “rush” to hike rates, given the Fed’s downgraded inflation forecasts.
And at the time, Yellen denied allegations that the Fed hiked in order to influence inflation expectations.
However, the minutes revealed that “Participants agreed that a fall in longer-term inflation expectations would be undesirable” although Fed officials “differed in their assessments of whether inflation expectations were well anchored.”
For the newbies out there, inflation expectations refer to (as the name implies) the rate of inflation that businesses, investors, and workers expect in the future.
This is an important concept because it informs the price-setting behavior of companies, wage negotiations, and a host of other things.
In fact, low inflation expectations due to a persistent deflationary mindset is often cited by the BOJ as the major reason why Japan has a problem with inflation, despite the BOJ’s super loose monetary policy.
The rationale for this is that the deflationary mindset in Japan keeps wage growth down. And anemic wage growth, in turn, leads to weaker demand for goods and services. And weaker demand means weaker domestic inflationary pressure, hence weak overall inflation in Japan.
Going back to the Fed, only “One participant pointed to the stability of a number of measures of inflation expectations in recent months.”
Meanwhile, “a few others suggested that continuing low inflation expectations may have been a factor putting downward pressure on inflation or that inflation expectations might need to be bolstered in order to ensure their consistency with the Committee’s longer-term inflation objective.”
3. Fed not sure why inflation is weak
The minutes showed that FOMC members had an extensive discussion as to why inflationary pressure remains weak despite tighter labor market conditions. And according to the minutes:
“These included a diminished responsiveness of prices to resource pressures, a lower natural rate of unemployment, the possibility that slack may be better measured by labor market indicators other than unemployment, lags in the reaction of nominal wage growth and inflation to labor market tightening, and restraints on pricing power from global developments and from innovations to business models spurred by advances in technology.”
Despite all those possible reasons (including low inflation expectations) the minutes didn’t reveal which one (or combination thereof) the Fed thinks is the primary culprit for the weak inflationary pressure, which heavily implies that the Fed probably doesn’t really know why inflation remains weak, so much so that:
“A few participants cited evidence suggesting that [the Fed’s] framework [for analyzing inflation] was not particularly useful in forecasting inflation.”
However, “most participants thought that the framework remained valid, notwithstanding the recent absence of a pickup in inflation in the face of a tightening labor market and real GDP growth in excess of their estimates of its potential rate.”
4. Fed divided on further hikes
As you’ve probably noticed by now, the minutes showed that the Fed devoted a large chunk of their discussions on inflation, with “several” seeing downside risks to inflation while “many” expect inflation to pick up but at a weaker-than-originally-estimated rate.
Given the divided outlook on inflation, it naturally follows that Fed officials were divided on the future path of the Fed Funds Rate.
In fact, “some” FOMC members even expressed that (emphasis mine): “the Committee could afford to be patient under current circumstances in deciding when to increase the federal funds rate further and argued against additional adjustments until incoming information confirmed that the recent low readings on inflation were not likely to persist and that inflation was more clearly on a path toward the Committee’s symmetric 2 percent objective over the medium term.”
In simpler terms, hold off on further hikes for now until inflation picks up.
However, “some other participants” (who are obviously hawkish) also “cautioned that a delay in gradually removing policy accommodation could result in an overshooting of the Committee’s inflation objective that would likely be costly to reverse, or that a delay could lead to an intensification of financial stability risks or to other imbalances that might prove difficult to unwind.”
5. Balance sheet unwind in “upcoming meeting”
The Fed may be split on inflation outlook and what it means for rate hikes. However, they “generally agreed that … it was appropriate to signal that implementation of the [balance sheet unwinding] program likely would begin relatively soon, absent significant adverse developments in the economy or in financial markets.”
In fact, “several participants” were ready to vote in favor of starting the balance sheet unwind during the July FOMC statement. However, “most preferred to defer that decision until an upcoming meeting.”
No specifics on which “upcoming meeting” the Fed was referring to, but since “several participants” were ready to start unwinding right then and there, it’s highly probable that the “upcoming meeting” refers to either the September or December FOMC meeting.
6. Fed worried about Trump
The Fed sounded more dovish overall on inflation but they remained upbeat on the prospects for U.S. economic growth.
However, “several participants” expressed some concerns related to Trump. Well, the Fed didn’t really name Trump, but that’s what they were doing in effect when they expressed “uncertainty about the course of federal government policy.”
To quote the minutes directly:
“[S]everal participants noted that uncertainty about the course of federal government policy, including in the areas of fiscal policy, trade, and health care, was tending to weigh down firms’ spending and hiring plans. In addition, a few participants suggested that the likelihood of near-term enactment of a fiscal stimulus program had declined further or that the fiscal stimulus likely would be smaller than they previously expected. It was also observed that the budgets of some state and local governments were under strain, limiting growth in their expenditures.”
The Greenback was already getting a beating before the FOMC minutes were released, thanks largely to this news from The Donald himself:
Rather than putting pressure on the businesspeople of the Manufacturing Council & Strategy & Policy Forum, I am ending both. Thank you all!
— Donald J. Trump (@realDonaldTrump) August 16, 2017
However, the minutes revealed that the Fed was divided on its inflation outlook, so much so that “some” FOMC members were calling for delays to further hikes until inflation picks up. And that apparently crushed the hopes of rate hike junkies, which is very likely why the Greenback encountered more sellers and was kicked even lower.