Fed minutes – September rate hike off the cards?

Not quite so “resonably confident”

The minutes to the Fed’s last meeting – July 28-29 – were released last night and a rate rise in September now appears a lot less likely. Despite noting that the conditions for a rate rise were “approaching”, the minutes showed that the Fed’s stance has become more dovish. Significantly, it noted that the conditions for a rate hike “had not been met” and that “almost all members [indicated] that they would need to see more evidence that…. inflation would return to the Committee’s longer-run objective over the medium term.”

The committee also expressed concerns about China, the strong Dollar and low oil prices. Given that turbulence in China has risen (and it has devalued its currency since the meeting took place) and the oil price has also fallen, the case for a rate hike in September is fast receeding. October or later is now most likely. Compared to 80% on Monday, only 40% of economists are now predicting a rate rise in September. The minutes, combined with yesterday’s CPI report, China, oil and my blog post on Monday, have clearly shifted sentiment.

On Monday I went through the framework that the Fed would need to consider before raising rates. I noted the pros and cons for a rate hike, but also how inflation is likely to remain low. The Fed has indicated that it needs to feel “reasonably confident” that inflation will move back towards target, but the minutes and CPI for July suggest this is unlikely to be the case in September. If only I had Datastream to dissect the numbers….

I don’t unfortunately, but what I do know is that yesterday’s CPI report showed that prices rose by 0.1% m/m in July, less than expected (0.2% m/m). Treasury yields and the Dollar have fallen as a result. With China devaluing its currency and oil prices falling, inflation looks set to fall further below the Fed’s target in the coming months. Even a strong rise in wages in the employment reports for August may not be enough for the Fed to consider raising rates when it next meets on September 16-17.

The two main arguments of the hawks and the doves (on the FOMC) are as follows.

The doves:

Some participants expressed the view that the incoming information had not yet provided grounds for reasonable confidence that inflation would move back to 2 percent over the medium term and that the inflation outlook thus might not soon meet one of the conditions established by the Committee for initiating a firming of policy. Several of these participants cited evidence that the response of inflation to the elimination of resource slack might be attenuated and expressed concern about risks of further downward pressure on inflation from international developments. Another concern related to the risk of premature policy tightening was the limited ability of monetary policy to offset downside shocks to inflation and economic activity when the federal funds rate was near its effective lower bound.

 

And the hawks:

Some participants, however, emphasized that the econ-omy had made significant progress over the past few years and viewed the economic conditions for beginning to increase the target range for the federal funds rate as having been met or were confident that they would be met shortly. A few of these participants judged that the stance of monetary policy, including the extraordinarily low level of the federal funds rate and the current size of the Federal Reserve balance sheet, was very accommodative. A couple of others thought that an appreciable delay in beginning the process of normalization might result in an undesirable increase in inflation or have adverse consequences for financial stability. Some participants advised that progress toward the Committee’s objectives should be viewed in light of the cumulative gains made to date without overemphasizing month-to-month changes in incoming data. It was also noted that a prompt start to normalization would likely convey the Committee’s confidence in prospects for the economy.

That looks like a fairly even argument to me, but perhaps the key lies in other excerpts of the minutes. For exmaple, “although it had seen further progress, the economic conditions warranting an increase in the target range for the federal funds rate had not yet been met”. Furthermore, and perhaps more importantly, it said “with almost all members indicating that they would need to see more evidence that economic growth was sufficiently strong and labor markets conditions had firmed enough for them to feel reasonably confident that inflation would return to the Committee’s longer-run objective over the medium term”.

For the nerds, here are the other main excerpts from the minutes, followed by my comments in brackets:

• Labour market conditions continued to improve [as expected]
• Consumer price inflation continued to run below the FOMC’s longer-run objective of 2 per-cent, restrained by earlier declines in energy prices and further decreases in non-energy import prices [not unsurprising]
  
• Market-based measures of inflation compensation were still low [not a major surprise but confirmation that inflation expectations remain low]
• On balance, labor market indicators suggested that underutilization of labor resources had diminished since early this year [could be seen as a tad hawkish, but not unexpected and nothing new]
• Activity in the housing sector improved somewhat in recent months but remained slow [recognition that this important sector is picking up]
• Corporate bond issuance re-mained strong in the second quarter; issuance of institu-tional leveraged loans picked up noticeably, likely due in part to tighter loan spreads as compared with the begin-ning of the year [indicates that financial stability concerns remain in check although they later did acknowledge that the high-yield bonds/credit “pointed to some increasing concerns”]
• Credit conditions remained tight for riskier borrowers, such as those with low credit scores, undocumented income, or high debt-to-income ratios [no sign that the subprime lending boom has returned]
• Outstanding balances of auto and student loans continued to expand at a robust pace through May. Banks indicated in the July SLOOS that their lending standards for credit card loans had eased somewhat relative to the past few years. However, a number of indicators suggested that terms on credit card loans remained tight, especially for subprime borrowers
• In China, stock prices fell substantially, prompting a number of policy and regulatory actions by Chinese officials to support the stock market [further confirmation to me that China is in big trouble]
• The staff lowered slightly its estimate of the longer-run natural rate of unemployment [I said they would do this in my last blog post]
• The risks to the forecast for real GDP and inflation were seen as tilted to the downside, reflecting the staff’s assessment that neither monetary nor fiscal policy was well positioned to help the economy withstand substantial adverse shocks [perhaps this is the dovish bit that analysts have focused on]
• A few participants observed that although GDP growth appeared to have picked up in recent months relative to the first quarter pace, the level of GDP remained lower than had been projected earlier in the year [outlook for the economy a bit more disappointing than expected]
• A couple of participants were concerned about the outlook for consumer spending, noting that spending had been disappointing in recent months even though real income had already been boosted by the lower gasoline prices and the improved labor market [again, disappointing outlook]
• Several participants noted that a material slowdown in Chinese economic activity could pose risks to the U.S. economic outlook [interesting to know – would this make them cautious to raise rates given China uncertainty?]
• Some participants also discussed the risk that a possible divergence in interest rates in the United States and abroad might lead to further appreciation of the dollar, extending the downward pressure on commodity prices and the weakness in net exports [more reason to be cautious on raising rates]
• Several participants noted that reports from business contacts in their Districts pointed to continued job gains and relatively strong labor markets. They cited anecdotal reports of firms having concerns about retaining workers and fac-ing difficulties in filling even medium- and lower-skilled jobs [these would be the hawks]
• However, several participants contended that, despite the progress over the past few years, some noticeable margins of slack remained, citing as evidence the high number of workers not actively searching for jobs but available and interested in work as well as the high share of employees working part time for economic reasons compared with pre-recession levels [And the doves… and two of the points I mentioned in Monday’s post]
• While business contacts in a number of Districts continued to report that the pace of wage increases had picked up, recent national readings on hourly compensation and average hourly earnings of employees had remained subdued [so some anecdotal evidence that wages are rising but the official data says no]

The full minutes are available on the Federal Reserve website.

Note: these views are mine, and mine alone. They do not reflect those of my employer (past, present or future) or anybody that has or will pay me money. They may be inaccurate and you should not rely on them, at all. They are also subject to change, at the drop of a hat.