Minutes of the 29-30 July FOMC meeting provided new evidence of an intensifying debate inside the Fed about when to respond to the actual and expected progress away from high unemployment and very low inflation. Overall the minutes reflect a slightly less dovish stance than Fed Chair Yellen’s testimony in July. This will only increase the focus on Yellen’s speech in Jackson Hole on Friday.
At the July meeting many participants noted that if convergence toward the FOMC’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated. Indeed, some participants viewed the actual and expected progress toward the Committee’s goals as sufficient to “call for a relatively prompt move” toward reducing policy accommodation to avoid overshooting unemployment and inflation targets.
In Fed chair Yellen’s congressional testimony in July she balanced her discussion of early rate hikes by also noting that rate increases might be delayed if economic performance disappoints. At the July FOMC meeting, however, the discussion seemed to focus on the possibility of earlier increases and not late increases.
Although the FOMC approved on a 9-1 vote keeping its dovish forward guidance for interest rates, the minutes indicated rising support for a change.
Many members thought a range of labour market indicators had improved more in recent months than they had earlier anticipated. “The characterization of labor market underutilization might have to change before long, particularly if progress in the labor market continued to be faster than anticipated”, the minutes said.
We continue to expect the Fed to turn more hawkish later this year and today’s FOMC minutes obviously support our view that markets will start pricing in more rate increases from the Fed as the economy continues to strengthen and the geopolitical concerns start to fade.
The minutes also suggested that the FOMC are closer to deciding which tools will be used to tighten when the time comes. Almost all participants agreed that it would be appropriate to retain the fed funds rate as the key policy rate, and they supported continuing to target a range of 25bp points for this rate at the time of liftoff and for some time thereafter.
Participants agreed that adjustments in the interest paid on excess reserves (IOER) would be the primary tool used to move the fed funds rate into its target range and influence other money market rates. In addition, most thought that temporary use of a limited-scale fixed-rate overnight reverse repurchase facility (ON RRP) would help set a firmer floor under money market interest rates during normalisation. Most participants anticipated that, at least initially, the IOER rate would be set at the top of the target range for the fed funds rate, and the ON RRP rate would be set at the bottom of the fed funds target range.
Longer-term they expressed the view that they would not continue to use reverse repos and would reduce their balance sheet “gradually and predictably”.
The Fed plans to make its updated exit strategy public “well before most participants anticipate the first steps in reducing policy accommodation to become appropriate”, the minutes said. That probably means sometime in the autumn, potentially as early as at the September FOMC meeting.
Nordea