As is often the case, one could linger for hours over the minutes of the Fed meetings, pulling out interesting bits and pieces to chew on. This one is no exception, but the short story in the January minutes is that the Fed was concerned enough about the outlook to shift to its current “patient” stance, but not so worried that they were contemplating a rate cut in the year ahead. They are also closer to ending the balance sheet reduction; I expect they will slow the pace they are reducing the balance sheet within the next two meetings with an eye toward ending entirely by the end of the year.
The operating procedures and balance sheet discussion came early in the meeting. Recall that the Fed announced in January they had decided to manage short-term rates in a system with ample reserves. With that in mind, the Fed sees that the end of “quantitative tightening” is upon us:
Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.
They also noted the implications of their plan on the mix of their asset holdings:
Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities.
In other words, they will eventually find themselves once again buying Treasuries to offset continued reduction in their mortgage holdings as they work to exit the housing business.
Participants were generally upbeat about the economy:
Participants agreed that over the intermeeting period the labor market had continued to strengthen and that economic activity had been rising at a solid rate
Still, they saw growth slowing in 2019 more than anticipated in December:
Participants generally continued to expect the growth rate of real GDP in 2019 to step down somewhat from the pace seen over 2018 to a rate closer to their estimates of longer-run growth, with a few participants commenting that waning fiscal stimulus was expected to contribute to the step-down. Several participants commented that they had nudged down their outlooks for output growth since the December meeting…
Recall that in December the median 2019 growth forecast was 2.3%. The above suggests that by January it had fallen to something closer to 2% (the Fed’s median estimate for longer-run growth was 1.9%). A particular concern was the investment outlook:
Participants noted that growth of business fixed investment had moderated from its rapid pace earlier last year.
With regards to inflation, hope springs eternal:
Participants continued to view inflation near the Committee’s symmetric 2 percent objective as the most likely outcome.
Despite the reality:
Some participants noted that some factors, such as the decline in oil prices, slower growth and softer inflation abroad, or appreciation of the dollar last year, had held down some recent inflation readings and may continue to do so this year. In addition, many participants commented that upward pressures on inflation appeared to be more muted than they appeared to be last year despite strengthening labor market conditions and rising input costs for some industries.
They took a fairly benign view of falling market-based measures of inflation compensation, favoring the interpretation that this was less about falling inflation expectations and more about declining risk premiums and a greater risk of downside to the inflation forecast. Stable survey measures of inflation expectations supported this view. Since then, however, the University of Michigan longer-run inflation measure slipped to 2.3%. Most interesting is that series has not begun to edge higher despite a period of unemployment that is supposedly persistently below its natural rate.
Not unexpectedly, the Fed worried about the financial markets:
Among those participants who commented on financial stability, a number expressed concerns about the elevated financial market volatility and the apparent decline in investors’ willingness to bear risk that occurred toward the end of last year.
These concerns played into their policy decision:
Participants observed that since then, the economic outlook had become more uncertain. Financial market volatility had remained elevated over the intermeeting period, and, despite some easing since the December FOMC meeting, overall financial conditions had tightened since September. In addition, the global economy had continued to record slower growth, and consumer and business sentiment had deteriorated. The government policy environment, including trade negotiations and the recent partial federal government shutdown, was also seen as a factor contributing to uncertainty about the economic outlook.
They subsequently concluded that they should hold rates constant and signal they would be patient with respect to future policy changes. Interestingly, I would argue that most of these factors were present at the December policy meeting, which would explain why markets puked in the wake of that decision to hike rates and signal more rate hikes to come. The Fed was then less willing to see what everyone else saw.
Policymakers on average retain a hawkish bias with respect to the likely direction of rates:
Many participants suggested that it was not yet clear what adjustments to the target range for the federal funds rate may be appropriate later this year; several of these participants argued that rate increases might prove necessary only if inflation outcomes were higher than in their baseline outlook. Several other participants indicated that, if the economy evolved as they expected, they would view it as appropriate to raise the target range for the federal funds rate later this year.
Note that they seemed focused on the possibility of additional rate hikes and not focused at all on cuts. Also, the Fed made clear that they will dump “patient” before any rate hike:
Many participants observed that if uncertainty abated, the Committee would need to reassess the characterization of monetary policy as “patient” and might then use different statement language.
This on the dot plot is interesting:
A few participants expressed concerns that in the current environment of increased uncertainty, the policy rate projections prepared as part of the Summary of Economic Projections (SEP) do not accurately convey the Committee’s policy outlook. These participants were concerned that, although the individual participants’ projections for the federal funds rate in the SEP reflect their individual views of the appropriate path for the policy rate conditional on the evolution of the economic outlook, at times the public had misinterpreted the median or central tendency of those projections as representing the consensus view of the Committee or as suggesting that policy was on a preset course. However, some other participants noted that the policy rate projections in the SEP are a valuable component of the overall information provided about the monetary policy outlook.
The ongoing debate at the Fed. Does the dot plot help or hurt? The Fed is having a hard time convincing market participants that the dot plot median is not a consensus forecast and that any of the individual forecasts are much more uncertain than commonly believed. This was particularly an issue in December when the median dot anticipated another two rate hikes in 2019 after the Fed pushed through what market participants already considered an ill-advised rate hike at that meeting. The Fed argues that was a forecast, not a promise. This and similar dynamics have been an ongoing issue. In my opinion, the Fed’s models make the dot plot inherently hawkish, which arguably sets expectations such that policy is less accommodative than the Fed believes.
All that said, many FOMC participants still find value in the dot plot in that it conveys the Fed’s reaction function. The challenge is finding a new version of the dot plot that retains this communications element while losing the problematic elements.
Bottom Line: Policy on hold through mid-year at least, the Fed still retains a modestly hawkish internal bias, the balance sheet reduction will soon be over, and the Fed still doesn’t know exactly what to do with the dot plot.