– Minutes Apt To Show Economic Confidence, Firming Intent Even Before Data Started Improving
By Steven K. Beckner
Written exclusively for InTouch Capital Markets
22nd May 2017
Minutes of the May 2-3 Federal Open Market Committee meeting will be clouded by the usual mists of time when they’re released Wednesday, but also by considerable changes in economic and political circumstances since Federal Reserve officials met to reconsider monetary policy.
The economic picture has improved greatly since the FOMC left the federal funds rate and its balance sheet unchanged on 3rd May. But the policy outlook has potentially been altered by the political maelstrom swirling just blocks from Fed headquarters.
As always, it’s important to guard against over-interpretation. The minutes comprise a snapshot of what policymakers were thinking three weeks ago — not how they feel about the economy and policy now in light of developments since the meeting.
But that doesn’t make them unimportant. The May meeting featured neither a press conference nor revised economic and rate projections. So the minutes will give us the first glimpse of what Chair Janet Yellen and her colleagues were thinking then.
It’s doubtful we’ll get any major revelations, but the minutes may provide useful insights.
We’ll be looking first, of course, for June rate hike signals. While the FOMC doesn’t pre-commit itself, we likely will be able to discern a definite, if conditional, predisposition to make a second rate hike next month. Based on what officials have said publicly and privately, the minutes likely will cement impressions the FOMC remains on course for further firming on both the rate and balance sheet fronts.
Plainly, policymakers were not discouraged by weak first quarter data. As the FOMC stated, it “views the slowing in growth during the first quarter as likely to be transitory and continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, labor market conditions will strengthen somewhat further, and inflation will stabilize around 2% over the medium term.”
Employment and inflation risks were deemed “roughly balanced.” So, the FOMC said it “expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.”
Remember that when the FOMC convened, it had almost no redeeming data to relieve the gloom that seemed to have settled over the economy.
Two days after the meeting, the Fed got welcome validation when the April employment report revealed a big rebound in non-farm payrolls, a drop in the unemployment rate to 4.4% and a 0.3% wage increase. More recently, we’ve seen rising retail sales, consumer prices and industrial production. The Atlanta Fed now projects 4.1% second quarter GDP growth.
Not surprisingly, Federal Reserve Bank presidents across the spectrum — Chicago’s Charles Evans, Kansas City’s Esther George, Cleveland’s Loretta Mester and Boston’s Eric Rosengren — have echoed the FOMC’s “transitory” judgment and reaffirmed the need for further rate hikes and for forging ahead on undoing quantitative easing.
An exception is St. Louis Fed chief James Bullard, who says the Fed’s rate plans may be too “aggressive” for an uneven economy. But he too advocates early balance sheet shrinkage.
On the whole, we have a group who are confident in a favorable outlook and determined to get on with “normalization,” lest they fall behind the curve and have to tighten credit more abruptly to counter inflationary “overheating” and/or excessive risk-taking.
The FOMC did not recast its “dot plot” in May, but had they done so, there is every reason to believe participants would have left largely intact their median projection of two more rate hikes this year; three in 2018, and another three in 2019 — taking the funds rate to the “neutral” rate of 3%. The minutes seem likely to tacitly reaffirm that.
It will be interesting to see if the minutes show progress on when and how to phase out the policy of reinvesting principal payments from mortgage-backed securities and rolling over maturing Treasury securities to prevent any passive shrinkage of the $4.5 trillion balance sheet.
The FOMC undoubtedly had further balance sheet discussions. It’s unlikely that agreement has been reached on exactly when and how to proceed, though. There’s a lot more talking to do before the Fed is ready to curtail reinvestments, and the subject will be a topic for every FOMC meeting until it does.
Policymakers have already coalesced around some principles: the reinvestment phase-out should be clearly communicated, gradual and predictable, and the balance sheet should ultimately be all Treasuries.
Yet to be determined is how small the balance sheet should be. That will depend on the preferred policy implementation framework. Some favor returning to relatively scarce reserves in which the New York Fed’s open market trading desk could precisely manage the funds rate within a rate “corridor.” Others would rather keep relatively large reserve balances and use a “floor” system of rate setting.
There’s much to do before a balance sheet strategy is announced. Dennis Lockhart, until recently Atlanta Fed chief, told me not long ago “scaling back reinvestments and shrinking the balance sheet is the equivalent of a certain number of basis points increase in the federal funds rate, and the Committee will have to estimate what that is.”
“I doubt that they (the FOMC) will want to announce the start of curtailing reinvestments at the same meeting that they raise the funds rate,” Lockhart said. “My guess is, if they stick with the two additional rate hikes, the FOMC will hike in June and September and do the (scaling back of reinvestment announcement) in December.”
“Once the Fed gets going with a predictable schedule of securities run-offs, it will be easier for the FOMC to do rate hikes and balance sheet shrinkage at the same time if warranted,” he told me.
One caveat: If more favorable economic winds were all the Fed had to consider its monetary course might seem entirely predictable. Alas there is a countervailing whiff of political instability generated by the vicious partisan conflict over President Trump’s alleged missteps. Some of the worst partisan political strife in American history threatens to derail the Trump administration’s pro-growth tax and regulatory reform agenda, hurt confidence and disrupt financial markets. Those winds weren’t blowing as strongly at the May meeting.
Still it would take a lot to sideline the Fed. Whereas in years past it almost seemed to look for excuses to stand pat, the Fed now seems determined to normalize at a gradual but steady pace.
Prior article by Steven Beckner for InTouch Capital Markets: Confident Fed Moving Ahead Toward Two-Pronged Tightening
Steven Beckner is a veteran financial journalist with four decades of experience of reporting on the Federal Reserve. Mr Beckner is also the author of Back From The Brink: The Greenspan Years (Wiley, 1997) and can also be heard speaking regularly for National Public Radio.