FOMC minutes review – the doves take off the kid gloves

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The minutes of the September FOMC meeting portrayed a Committee that on the whole has not dramatically shifted its baseline criteria for the labour market and inflation, yet is keenly aware of the downside risks to its forecasts from a host of factors. These include slower growth abroad, sustained dollar appreciation, low productivity at home and a continued slow recovery in residential construction.

So it’s highly unlikely that, at its 28-29 October meeting (1), the Committee would make substantial changes to either its forward guidance on interest rates or its characterisation of labour market slack, especially given some recent tightening of financial market conditions.

Unsurprisingly, given the tone of some of the September pre-meeting speeches, “several” Committee members noted that the forward guidance on the federal funds rate (2) was somewhat out of keeping with their own expectations for lift-off and the pace of rate increases, and that the forward guidance was not sufficiently data-dependent.

However, the September minutes contain a strong and lengthy rebuttal of these arguments that was similar to Fed Chair Janet Yellen’s own comments during the post-meeting press conference, which suggests that she actively participated in this discussion and in the crafting of this section of the minutes.

The discussion also noted that risk management considerations argue for maintaining the forward guidance – in other words, that the costs associated with downside economic shocks are much larger than those associated with upside surprises to growth or inflation, since in the latter case the Committee can compensate via a steeper path of rate increases.

Also worth noting is that the Committee appears genuinely to appreciate the communication challenges it will face should it need to change the forward guidance in the future, arguing for a cautious approach to avoid a sharp reaction from financial markets.

Unsurprisingly, given the somewhat lacklustre initial August employment report, debate over the characterisation of labour market slack was not particularly divisive: “Most participants judged that there remained significant underutilisation of labour resources” while only a “few” expressed reservations on this.

So where next? In her press briefing, Yellen said she believes the forward guidance has always been data-dependent and that it gives the Committee the flexibility to respond to changing economic conditions. These views were reinforced in the meeting minutes. The “considerable time to lift-off” language will remain in the statement, though on a technical point, the reference to the end of asset purchases could simply be removed because they will be coming to an end.

Should non-farm payrolls continue to grow at 200 000 jobs a month, and should alternative measures of labour market slack show similar improvements, the “considerable time” language may come out at the December meeting.

However, if some of the downside risks highlighted in the statement remain a concern in the months ahead, such language could certainly stay in the statement until the January meeting, even if the Committee’s expectations for lift-off haven’t shifted to a later date. On an historical note, the 2004 tightening cycle saw just such an approach – the language about a “considerable period to lift-off” remained in the statement until January 2004, with lift-off occurring in June of that year.

Regardless of the exact timing of this important language change, it will likely be replaced with text assuring investors that while the first rate increase is approaching, it is not imminent. This could take the form of a reference to remaining labor market slack or overall progress towards achieving the Fed’s employment and inflation mandates. Alternatively, the Committee may rely on language that is similar in spirit to the approach used ahead of the prior tightening cycle, when FOMC statements indicated that the Fed could be patient in removing policy accommodation.

(1) The FOMC holds eight regularly scheduled meetings per year at which it reviews economic and financial conditions, determines the appropriate stance of monetary policy and assesses the risks to its long-run goals of price stability and sustainable economic growth.
(2) The federal funds rate is the interest rate at which depository institutions lend balances at the Fed to other depository institutions overnight.
Steven Friedman

Senior Investment Strategist

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