Minutes from the 16-17 December FOMC meeting indicate that the Fed is still serious about raising rates later this year, despite the impact of falling oil prices on inflation and slow growth abroad.
Overall, the minutes of the December FOMC meeting support our interpretation of the post-meeting statement and Fed Chair Yellen’s signals at the press conference. At the meeting the Fed dropped its assurance that it will not raise rates for a “considerable time”, replacing it with a commitment to be “patient” in beginning to normalise interest rates.
According to the minutes, the reference to “patience” indicates that the Fed is unlikely to begin the normalization process for “at least the next couple of meetings.” At the December press conference Fed Chair Yellen said that “a couple” means two, inferring that an April rate hike is possible.
As expected, the minutes downplayed the impact of falling oil prices and the stronger USD on inflation. Thus, most FOMC participants saw these influences as temporary and thus continued to expect inflation to move back gradually to the 2% longer-run objective. Indeed, the minutes suggest that the Fed would be willing to raise rates even if inflation remains well below target, as long as it is still confident that it is on course to get there eventually.
While the December meeting occurred before the latest headlines about Greece and Russia, many FOMC participants regarded slow growth abroad as a significant risk to the US economy when they met in December. However, they downplayed those concerns in part because they expected policy makers abroad to respond with further stimulus measures, the minutes show.
Overall, the downside risks from abroad to the domestic economy were seen as “nearly balanced by risks to the upside,” according to the minutes. Indeed, the minutes show that FOMC participants generally regarded the net effect of the recent decline in energy prices as “likely to be positive for economic activity and employment.”
Our baseline scenario is that the Fed drops the “patient” phrase in April and hike rates in June. We continue to see the fed funds rate at 1.25% by end-2015 and 2.50% by end-2016.
Here follows a few key extracts from the December minutes.
On risks to the economic outlook:
“The risks to the outlook for economic activity and the labor market were seen as nearly balanced. Some participants suggested that the recent domestic economic data had increased their confidence in the outlook for growth going forward.“
“Participants generally regarded the net effect of the recent decline in energy prices as likely to be positive for economic activity and employment. However, many of them thought that a further deterioration in the foreign economic situation could result in slower domestic economic growth than they currently expected.”
Especially on foreign risks:
“Many participants regarded the international situation as an important source of downside risks to domestic real activity and employment, particularly if declines in oil prices and the persistence of weak economic growth abroad had a substantial negative effect on global financial markets or if foreign policy responses were insufficient. However, the downside risks were seen as nearly balanced by risks to the upside.”
“Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.”
On inflation and inflation expectations:
“Participants generally anticipated that inflation was likely to decline further in the near term, reflecting the reduction in oil prices and the effects of the rise in the foreign exchange value of the dollar on import prices. Most participants saw these influences as temporary and thus continued to expect inflation to move back gradually to the Committee’s 2 percent longer-run objective as the labor market improved further in an environment of well-anchored inflation expectations.”
“Although a few participants suggested that the recent uptick in the employment cost index or average hourly earnings could be a tentative sign of an upturn in wage growth, most participants saw no clear evidence of a broad-based acceleration in wages.”
“Survey-based measures of longer-term inflation expectations remained stable, although market-based measures of inflation compensation over the next five years, as well as over the five-year period beginning five years ahead, moved down further over the intermeeting period. Participants discussed various explanations for the decline in market-based measures, including a fall in expected future inflation, reductions in inflation risk premiums, and higher liquidity and other premiums that might be influencing the prices of Treasury Inflation-Protected Securities and inflation derivatives.”
“In the end, participants generally agreed that it would take more time and analysis to draw definitive conclusions regarding the recent behavior of inflation compensation.”
On the timing of lift-off in rates:
“Most participants thought the reference to patience indicated that the committee was unlikely to begin the normalization process for at least the next couple of meetings.”
“With lower energy prices and the stronger dollar likely to keep inflation below target for some time, it was noted that the Committee might begin normalization at a time when core inflation was near current levels, although in that circumstance participants would want to be reasonably confident that inflation will move back toward 2 percent over time.”
On exit strategy tools:
The FOMC decided to extend the testing of its overnight reverse repo facility for another year, through 29 January 2016. The minutes said the extension of the tests “signaled nothing about either the timing of the start of policy normalization” or how long the reverse repo program might be kept in place.
The Fed said it was putting aside plans to create another facility to help it raise rates called segregated accounts, citing “operational, regulatory, and policy issues” that are unlikely to be addressed in a “timely fashion.” “It was therefore decided that further work to implement such accounts would be shelved for now.”
Nordea