FOMC Minutes: Inflation, China & Mechanics

January 6, 2016
Below are the key paragraphs from the minutes to the December 15th - 16th FOMC meeting. We have highlighted some of the key sentences in these paragraphs. After assessing the outlook for economic activity, the labor market, and inflation and weighing the uncertainties associated with the outlook, members agreed to raise the target range for the federal funds rate to ¼ to ½ percent at this meeting. A number of members commented that it was appropriate to begin policy normalization in response to the substantial progress in the labor market toward achieving the Committee’s objective of maximum employment and their reasonable confidence that inflation would move to 2 percent over the medium term. Members agreed that the postmeeting statement should report that the Committee’s decision reflected both the economic outlook and the time it takes for policy actions to affect future economic outcomes. If the Committee waited to begin removing accommodation until it was closer to achieving its dual-mandate objectives, it might need to tighten policy abruptly, which could risk disrupting economic activity. Members observed that after this initial increase in the federal funds rate, the stance of monetary policy would remain accommodative. However, some members said that their decision to raise the target range was a close call, particularly given the uncertainty about inflation dynamics, and emphasized the need to monitor the progress of inflation closely. Participants also discussed readings from various market- and survey-based measures of longer-run inflation expectations. Recently, some of the available surveys had reported softer longer-run inflation expectations, while others suggested still-stable expectations. In addition, the market-based measures of inflation compensation that had declined earlier were still at low levels. A number of participants noted, based on historical patterns, that some of the survey-based measures could be overly sensitive to energy price fluctuations rather than indicating shifts in perceptions of underlying inflation trends and that the declines in the market-based measures could reflect changes in risk and liquidity premiums. Many concluded that longer-run inflation expectations remained reasonably stable. However, some expressed concerns that inflation expectations may have already moved lower, or that they might do so if inflation persisted for much longer at a rate below the Committee’s objective. Factors cited by participants as contributing to their outlook that inflation will rise over the medium term included recent signs of a pickup in wage growth, their expectation of tighter resource utilization, their expectation that the effects of recent appreciation in the dollar and declines in oil prices on inflation will fade, their anticipation that inflation expectations will remain at levels consistent with the FOMC’s longer-run objective, and still-accommodative monetary policy. Participants generally agreed that the drag on U.S. economic activity from the appreciation of the dollar since the summer of 2014 and the slowdown in foreign economic growth, particularly in emerging market economies, was likely to continue to depress U.S. net exports for some time. Many expressed the view that the risks to the global economy that emerged late this summer had receded and anticipated moderate improvement in economic growth abroad in the coming year as currency and commodity markets stabilized. However, participants cited a number of lingering concerns, including the possibility that further dollar appreciation and persistent weakness in commodity prices could increase the stress on emerging market economies and that China could find it difficult to navigate the cyclical and structural changes under way in its economy. Several upside risks to the U.S. outlook also were noted, including the possibility that declining energy prices could spur consumer spending more than currently anticipated. Financial conditions tightened modestly over the intermeeting period. Quotes in financial markets and survey results suggested that investors were quite confident that the Committee would raise the federal funds target range 25 basis points at the current meeting. Concerns among investors about the high-yield bond market increased notably in the days before the meeting after an open ended mutual fund specializing in junk bonds suspended redemptions and closed. In their discussion, several participants commented that markets for leveraged finance had been correcting since midyear—particularly for the most risky assets, including those associated with energy firms—and noted that the widening of credit spreads in corporate bond markets appeared to be largely due to the repricing of riskier assets. Bottom Line: In the Minutes for the meeting where the Fed hiked interest rates for the first time in 7 years, they noted that some members said that their decision to raise the target range was a “close call”, particularly given the uncertainty about inflation dynamics. The Fed discussed longer-run inflation expectations and factors contributing to their outlook that inflation will rise over the medium term. "However, some expressed concerns that inflation expectations may have already moved lower." Moreover, “participants cited a number of lingering concerns, including the possibility that further dollar appreciation and persistent weakness in commodity prices could increase the stress on emerging market economies and that China could find it difficult to navigate the cyclical and structural changes under way in its economy.“ It was noted that the System’s reverse repurchase (RRP) agreement operations continued to provide a soft floor under short-term interest rates.
Article by contingentmacro