Minutes from the 28-29 October FOMC meeting indicate that Fed officials were not overly concerned about turbulence in financial markets, weaker foreign growth, a stronger dollar and risks inflation expectations might become unanchored.
Thus, against the background of continued improvements in the domestic economy and the labour market all but one official agreed to end the Fed’s asset purchases.
With the QE programme now completed, many officials are looking to drop the “considerable time” language in the post-meeting statement, but the minutes gave no indications of when and how this guidance will be changed.
Overall, with the minutes showing broad agreement that slack in the labour market is diminishing they support our view that it is only a matter of when, rather than if, the Fed starts normalising monetary policy.
The minutes indicate that the timing will partly depend on longer-term inflation expectations. Thus the decline in long-term inflation expectations reported in the University of Michigan consumer sentiment survey last Friday is likely to attract continued market attention. However, as we see it, even 5-10 year inflation expectations in the Michigan survey seem correlated with the pace of oil price changes. This implies that unless oil prices continue to drop sharply, we should expect this survey-based measure of inflation expectation to rebound.
We still expect the first Fed rate in June 2015. Risks to this call are seen as fairly balanced, i.e. a hike already in March cannot be ruled out, in our view.
Here follows a few key extracts from the October minutes.
On inflation expectations:
“Survey-based measures of inflation expectations remained well anchored, but market-based measures of inflation compensation over the next five years as well as over the five-year period beginning five years ahead had declined over the intermeeting period. Various explanations were offered for the decline in the market-based measures, and participants expressed different views about how to interpret these recent movements. The explanations included a decline in inflation risk premiums, possibly reflecting a lower perceived probability of higher inflation outcomes; and special factors, including liquidity risk premiums, that might be influencing the pricing of Treasury Inflation-Protected Securities and inflation derivatives.”
“A couple of participants noted that it was likely too early to draw conclusions regarding these developments, especially in light of the recent market volatility. However, many participants observed that the Committee should remain attentive to evidence of a possible downward shift in longer-term inflation expectations; some of them noted that if such an outcome occurred, it would be even more worrisome if growth faltered.”
On turbulence in financial markets ahead of the meeting:
“In their discussion of financial market developments and financial stability issues, participants judged that the movements in the prices of stocks, bonds, commodities, and the U.S. dollar over the intermeeting period appeared to have been driven primarily by concerns about prospects for foreign economic growth.”
“Some participants pointed out that, despite the market volatility, financial conditions remained highly accommodative and that further pockets of turbulence were likely to arise as the start of policy normalization approached.”
On foreign economic conditions and the USD:
“In discussing economic developments abroad, participants pointed to a somewhat weaker economic outlook and increased downside risks in Europe, China, and Japan, as well as to the strengthening of the dollar over the period. It was observed that if foreign economic or financial conditions deteriorated further, U.S. economic growth over the medium term might be slower than currently expected. However, many participants saw the effects of recent developments on the domestic economy as likely to be quite limited.”
“Several participants judged that the decline in the prices of energy and other commodities as well as lower long-term interest rates would likely provide an offset to the higher dollar and weaker foreign growth, or that the domestic recovery remained on a firm footing.”
Nordea