Recall that Federal Open Market Committee (FOMC) members had raised their interest rate range by 25 basis points to 1.00% – 1.25% in June.
The move was widely expected, so why did dollar traders still react strongly to the June meeting minutes release? The answer is in the details. No really.
You see, many market players were looking for more details on the Fed’s plan to normalize its balance sheet. Meanwhile, others had hoped to pick up hints on how hawkish Fed members still are and how it will affect the pace of their interest rate hikes.
Unfortunately, the only thing we now know for sure is that Fed members themselves can’t decide what they know for sure. Let’s take a look at the five questions that they tried to answer:
1. Is the period of low inflation temporary?
If you’ve read the 6 Highlights from the June FOMC Statement, then you’ll know that Fed members downgraded their 2017 inflation forecasts even as they retained their 2018 and 2019 estimates.
The Fed attributed their lower estimates to “idiosyncratic (read: probably one-off) factors, including sharp declines in prices of wireless telephone services and prescription drugs” and stressed that they “have little bearing on inflation over the medium run.”
But the minutes revealed that while Fed members generally continue to expect inflation to “stabilize around the Committee’s 2% objective in the medium-term,”
“Several participants expressed concern that progress toward the Committee’s 2% longer-run inflation objective might have slowed and that the recent softness in inflation might persist.”
That is, several have noted that the “upward pressure on inflation from resource utilization” is now weaker than they were in “previous decades” and that they might not boost inflation as much this time.
2. Should we allow unemployment to undershoot our initial estimates?
What’s the use of aiming for low unemployment rate if it won’t lead to higher inflation? For newbies out there, you should know that know that more jobs usually means more moolah for goods and services, which then boosts consumer prices.
But with higher employment leading to “only modest responses of nominal wage growth and inflation,” some are now thinking of letting unemployment rate undershoot their initial estimates for a spell to achieve their inflation targets:
“[Several participants] noted that the longer-run normal rate of unemployment is difficult to measure and that recent evidence suggested resource pressures generated only modest responses of nominal wage growth and inflation.
Against this backdrop, possible benefits cited by policymakers of a period of tight labor markets included a further rise in nominal wage growth that would bolster inflation expectations and help push the inflation rate closer to the Committee’s 2% longer-run goal, as well as a stimulus to labor market participation and business fixed investment.”
And as a bonus,
“…the symmetry of the Committee’s inflation goal might be underscored if inflation modestly exceeded 2% for a time; as such an outcome would follow a long period in which inflation had undershot the 2% longer-term objective.”
Several members nixed the idea believing that sustained undershooting could lead to “a sharp rise in inflation that would require a rapid policy tightening” and would eventually lead to economic downturn. Other participants were chill on the plan, however, as they think they can “readily respond” to a sharp rise in inflation if needed.
3. How many times should we raise rates next year?
In its June statement, the Fed’s fund rates projection suggested that four Fed officials are open to at least one more rate hike, eight Fed officials are open to just one more hike, and four would be unwilling to support further hikes.
The discomfort among those who aren’t into more rate hikes is detailed in the minutes:
“A few participants who supported an increase in the target range at the present meeting indicated that they were less comfortable with the degree of additional policy tightening through the end of 2018 implied by the June SEP median federal funds rate projections. These participants expressed concern that such a path of increases in the policy rate, while gradual, might prove inconsistent with a sustained return of inflation to 2%.”
So while members still support a gradual approach to rate hikes and believe that the plan would lead to a 2% inflation rate, it looks like they would need a much bigger incentive if they want to keep up their pace next year.
4. When do we start normalizing our balance sheet?
Back in June Janet Yellen and her gang finally rolled out details on HOW they would execute their balance sheet normalization.And based on the meeting’s minutes, we now know that (a) they want to announce a “specific timetable” this year and that (b) they expect their announcement re: start of normalizing to have “limited” impact on financial markets.
However, it seems like members can’t agree on WHEN exactly they’ll start normalizing their balance sheet. Specifically,
“Several preferred to announce a start to the process within a couple of months; in support of this approach, it was noted that the Committee’s communications had helped prepare the public for such a step.
However, some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation.”
5. Will normalization affect our pace of rate hikes?
Analysts have noted that reducing the Fed’s balance sheet would have the same effect as raising interest rates since both tend to reduce money supply in the markets.
Well, it seems like Fed members aren’t sure if it will either. Apparently, “several participants” believe that normalization would lead to interest rates following “a less steep path than it otherwise would.”
Meanwhile, “other participants” don’t see the move factoring “heavily in decisions about the target range” while “a few” think that the effect on their decisions would be modest.
Not surprisingly, dollar bulls – who were already worried if the Fed COULD raise rates for a third time this year – didn’t appreciate the lack of FOMC members’ consensus on key issues.
The dollar ended up losing pips against its major counterparts and has yet to recover to its pre-FOMC minutes levels as of writing.
So it looks like the June meeting minutes didn’t help much in answering most of our questions. This is unfortunate for Yellen and her team who will rely heavily on clear communication to avoid unwanted volatility during their balance sheet normalization process.
Until they give more clues on their next steps, traders like you and me will have to look to Uncle Sam’s major economic reports – such as today’s NFP release – for clues on how aggressive the Fed could be in their tightening game.