Minutes from the FOMC’s December meeting, in which the federal funds rate was raised 25 basis points to a range of 2.25% to 2.50%, noted participants contrasting still-strong economic data with increased worries in financial markets (and among business contacts) about downside risks to the outlook.
The tightening in financial conditions was enough to cause FOMC participants to migrate down their expectations for future policy rate increases as well as edge down their forecasts for future economic growth. However, most members saw growth as continuing broadly in line with their expectations.
A few participants honed in on the recent weakness in inflation as reason enough to hold off raising rates, even at the December meeting. Still, most participants saw risks to the inflation outlook as relatively balanced.
The minutes note the impact of global developments and concerns in several occasions. Global growth concerns are contributing to the tightening in financial conditions and uncertainty about the future course of fed policy.
Key Implications
U.S. economic growth has long been expected to slow as the sugar high from fiscal stimulus fades. The question for FOMC members and ourselves is whether the economy can transition to a slower, but still healthy, pace of growth, or whether the simple act of slowing is enough to throw confidence into a tailspin and catalyze an outright downturn.
The FOMC continues to emphasize data dependence over forward guidance. This is prudent. As long as economic conditions remain resilient, financial conditions are likely to ease and downside risks to the outlook will diminish. If, on the other hand, data begin to deteriorate (perhaps reflecting the impact of tighter financial conditions), concerns will be exacerbated and the cycle could turn from virtuous to vicious. In this environment, the Fed is likely to sit on its hands until the signal in the data is more clear.
Concerns about global growth appear to be weighing more on the decisions of FOMC members as a source of downside risk to the outlook, while also adding uncertainty as to the impact of fed policy. Expect this to continue as it generally reflects China’s growing importance in the global economy. As long as worries about a hard landing in China are a theme in financial markets, the transmission of global outcomes to the U.S. will remain important.
