We’ve finally got our hands on the minutes for the January meeting! Time to take a closer look at the dovish hints that Fed officials dropped during the January 27 FOMC statement.
If you’ve got plenty of things to do and pips to catch, just take a look at these major takeaways from the FOMC minutes:
1. Tighter financial conditions are a risk factor
Almost all FOMC members agreed that the following recent events are good indicators of tighter financial conditions in the United States:
- Declines in equity prices
- A widening in credit spreads
- A further rise in the exchange value of the dollar
- An increase in financial market volatility
The FOMC members argued among themselves on what’s causing tighter financial conditions, but they all agreed on what the effects are if tighter financial conditions persist:
“The effects of these financial developments, if they were to persist, may be roughly equivalent to those from further firming in monetary policy.”
To those who have difficulty understanding the alien language knows as economic-speak, it just means that tightening financial conditions have roughly the same effect as hiking rates.
Anyhow, this is not really that new since Dovish Dudley already spilled the beans earlier and Fed Chairperson Janet Yellen said as much during her testimony before the House Financial Services Committee.
2. Inflation expected to stay lower for longer
Most FOMC members and their staff still expect that inflation will gradually rise to the Fed’s 2% target “once energy prices and the prices of non-energy imports stabilized and as the labor market strengthened further.”
However, “the further decline in energy prices and the additional appreciation of the dollar likely implied that inflation would take somewhat longer than previously anticipated to rise to the Committee’s objective.”
3. China may be a problem
Specifically, a number of FOMC members were worried that China’s slowdown may worsen, which may potentially drag down the U.S. economy, as well as emerging market economies (EME) and commodity-producing countries.
And as I noted in my most recent Monthly Economic Review of the U.S. economy, U.S. GDP growth has been slowing down on both an annualized and quarter-on-quarter basis, which is not really an ideal situation to hike rates.
The FOMC members and their staff tried to play the GDP slowdown off by attributing it to “reduced inventory investment and a weather-related slowing in consumer spending on energy services.” That’s right. They’re blaming the weather.
Below is the pertinent part of the FOMC minutes on China, if you want to read the details:
“Regarding the foreign economic outlook, it was noted that the slowdown in China’s industrial sector and the decline in global commodity prices could restrain economic activity in the EMEs and other commodity-producing countries for some time. Participants discussed recent developments in China, including the possibility that structural changes and financial imbalances in the Chinese economy might lead to a sharper deceleration in economic growth in that country than was generally anticipated. Such a downshift, if it occurred, could increase the economic and financial stresses on other EMEs and on commodity producers, including Canada and Mexico. Moreover, global financial markets could continue to be affected by uncertainty about China’s exchange rate regime. While the exposure of the United States to the Chinese economy through direct trade ties was limited, a number of participants were concerned about the potential drag on the U.S. economy from the broader effects of a greater-than-expected slowdown in China and other EMEs.”
4. More downside risks for the U.S. economy
FOMC members were pretty happy that the labor market remained robust. They even pointed out that wages continued to grow. However, they were worried that consumer spending hasn’t been picking up as much.
They were also disappointed at production levels, especially declining manufacturing output. They also listed recent developments in commodity and financial markets as well as “the possibility of a significant weakening of some foreign economies” as risk factors. Given all that, the FOMC members concluded that:
“Participants judged that the overall implication of these developments for the outlook for domestic economic activity was unclear, but they agreed that uncertainty had increased, and many saw these developments as increasing the downside risks to the outlook.”
5. A rate hike is still in the cards, but…
According to the minutes, FOMC members “continued to expect that gradual adjustments in the stance of monetary policy would be appropriate,” but “they emphasized that the timing and pace of adjustments will depend on future economic and financial market developments and their implications for the medium-term economic outlook.”
In short, a rate hike is still in the cards, but the Fed’s decision will ultimately be data-dependent. In addition, FOMC members were happily talking about the “size and timing of adjustments in the target range for the federal funds rate going forward” during the December meeting, but the recent minutes revealed that they were a bit more cautious:
“Participants discussed whether their current assessments of economic conditions and the medium-term outlook warranted either increasing the target range for the federal funds rate at this meeting or altering their earlier views of the appropriate path for the target range for the federal funds rate.”
In a nutshell, the FOMC minutes verify and expound on the Fed’s switch to a more dovish tone, as initially revealed during the January 27 FOMC statement.
The Fed is still looking to hike rates, but the FOMC members are wary of recent developments in the domestic front as well as abroad, which will likely keep many interest rate junkies away from the Greenback.