October FOMC minutes: stale information on lift-off, but some fresh news on the longer run outlook

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I had taken from the October policy statement that the Federal Open Markets Committee (FOMC – also known simply as the ‘Committee’) had an increased level of confidence in their short-term economic outlook and the appropriateness of a December start to policy normalisation. The October meeting minutes were certainly consistent with this interpretation. Participants seemed willing to look through weakness in the data heading into the meeting, such as a second disappointing payrolls report at the beginning of October and disappointing retail sales, and instead focused on cumulative progress in reducing labour market slack and “solid underlying momentum” in household and business sector demand.

We already knew from changes to the October statement that global developments had become much less of an immediate concern. Still, the minutes were striking for just how little time was spent discussing the global setting compared to the September minutes. For example, there is not a single reference to China in the sections of the October minutes describing Federal Open Market Committee (FOMC) participants’ views on current conditions, the economic outlook or policy considerations.

A Committee more confident that incoming data would be consistent with their short-term forecasts is reflected in the discussion around the timing of lift-off: “Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labour market, and inflation, … conditions [for lift-off] could well be met by the time of the next meeting” (on 15-16 December 2015). In contrast, the September minutes stated that the conditions for lift-off “would likely be met” by year-end.  This is a subtle change, but one intended to signal a higher degree of confidence that beginning policy normalisation at the December meeting would be appropriate. And their confidence must be even higher now, given that uncertainty regarding the labour market outlook should be lower following a very strong October employment report. The consumer price inflation (CPI) data published on 17 November 2015 has also likely bolstered their confidence in the inflation outlook, given the modest firming in services CPI even after stripping out shelter and medical services (see Exhibits 1, 2 and 3 below).

Exhibit 1: In October 2015 the headline consumer price index (CPI) rose by 0.2% relative to a year earlier but remains far from the rate of 2% considered by the Federal Reserve to be consistent with its statutory mandate (Exhibit 1 shows the changes in the US consumer price index for the period between 30/10/80 and 30/10/15). The rate of CPI has been running below the Fed’s objective since May 2012.

FedEx3actually1

Source: Bloomberg, BNP Paribas Investment Partners, as at 23 November 2015

 

Exhibit 2: Recent CPI data has likely bolstered confidence among Federal Reserve policymakers that inflation is rising in the US. Data published on 17/11/15 showed that core CPI (excluding food and energy) rose 0.2% on a year-on-year basis in October 2015 – Exhibit 2 shows changes in the core inflation rate on a year-on-year basis for the period between 1 November 2009 and 23 November 2015

FedEx1

Source: Bloomberg, BNP Paribas Investment Partners, as at 23 November 2015

 

Exhibit 3: Prices for services (not just rents but also health care, auto insurance and cinema tickets) are rising in the US – data published on 17/11/15 showed prices of services (excluding energy) rose the most since 2008 (US CPI Urban Consumer Services less energy services, year-on-year, non-seasonally adjusted).

FedEx2

Source: Bloomberg, BNP Paribas Investment Partners, as at 23 November 2015

 

The minutes also provided interesting colour on the October statement’s new language on “whether it will be appropriate to raise the target range at its next meeting”. As I wrote at the time, I did not think the Committee would have strengthened this language unless it had a relatively high level of confidence in its short-term forecasts, because the Committee would not want to risk another communications error following the volatility it engendered at the time of the September meeting. The discussion in the minutes makes clear that the Committee discussed the signaling risks of the new language, but still saw the change as necessary to push against market expectations that had increasingly shifted to a 2016 lift-off.

In some sense, the minutes are already quite stale given that recent data in the aggregate has only made a December lift-off more likely. As such, the first section of the minutes, regarding a staff presentation to the FOMC on equilibrium real interest rates, is likely most consequential. The presentation and subsequent discussion highlight that estimates of the equilibrium real policy rate are quite low relative to the pre-crisis period, so that even modest increases in the target rate might serve to restrain growth and further tightening in labour market conditions. The discussion has possible implications for the “dot plot” in the Summary of Economic Projections. To the extent that FOMC participants found the staff presentation persuasive, we might see the median longer-run equilibrium fed funds rate in the dot plot come down a bit further in subsequent SEPs. However, I should caution that there would need to be a wholesale rethink of the outlook for potential growth in order for the longer-run median dot to move significantly lower.  And I do not think this would be consistent with a modest recovery in productivity growth that is likely in the Committee’s baseline forecast.

Steven Friedman

Senior Investment Strategist

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