The minutes from the June meeting where it opted to raise rates a quarter point showed that Federal Open Market Committee participants generally saw the outlook for economic activity and the medium-term outlook for inflation as little changed since May. Therefore, it viewed a continued removal of monetary policy accommodation as being appropriate.
In light of surprisingly low recent readings on inflation, participants expected that inflation on a 12-month basis would remain somewhat below 2 percent in the near term. Most participants viewed the recent softness in price data as largely reflecting idiosyncratic factors including sharp price declines for wireless phone services and prescription drugs. As these transitory impacts wane and the labor market strengthens further, participants expect that inflation would stabilize around the Committee’s 2% objective over the medium term.
Unsurprisingly, views on inflation were mixed. “Several” participants pointed to recent increases in import prices as consistent with inflation stabilizing around 2% over the medium term. While “several” others expressed concern that progress towards the 2% objective has slowed, and that the recent softness in inflation might persist. But, overall near-term risks to the economic outlook were viewed as roughly balanced, and that the Committee should continue to monitor inflation developments closely.
One member (likely Kashkari, who dissented on the rate hike) did prefer to keep the fed funds rate unchanged until inflation was actually moving toward the 2% longer-run objective. Also, a few participants who supported the increase in the funds rate in June indicated they were less comfortable with the degree of additional tightening in 2018 (currently 3 hikes in June’s SEP), worried that it is inconsistent with a sustained return to the 2% inflation target.
On the plus side, a number of participants cited that improved prospects for foreign economic growth meant risks to the U.S. economic outlook from overseas had diminished in the intermeeting period. Moreover, job gains were viewed as having moderated, but had been solid on average, household spending had picked up, and business fixed investment had continued to expand.
On business investment, contacts in many districts remained optimistic about business prospects, supported in part by improved global conditions. However, that optimism appears to have abated somewhat in part due to diminished prospects for fiscal stimulus. Notably some large firms had curtailed capital spending due to uncertainty about changes in fiscal policy.
The Committee expected to begin implementing its balance sheet normalization plan in 2017, but there were a range of views on exact timing. Several participants preferred to announce the start of reducing reinvestments within a couple of months (meaning the July or September meeting), while others preferred to wait until later in the year in order to assess the economic outlook and inflation developments.
The Fed had outlined its plan to gradually reduce its holdings by tapering reinvestments in its Treasury and MBS portfolio in June along with its statement. The Fed expects to cap runoff at $10 billion per month initially ($6bn for UST/$4bn for MBS) before raising it to $50bn per month within a year, with the same 60/40 split between UST and MBS. The implications of this are discussed in TD’s recent report.
Key Implications
For now the consensus view among FOMC participants is that while near-term inflation would remain somewhat below 2% due to idiosyncratic factors, the economic outlook for moderate growth and labor market tightening is expected to see it stabilize around the 2% objective over the medium term. However, it is clear three months of soft inflation readings have members concerned, with some questioning whether three quarter point hikes in 2018 are necessary given weakness in the recent data. As outlined in our latest forecast, the risks are skewed to two hikes in 2018, rather than our baseline expectation of three.
The minutes didn’t clear up the precise timing on when in 2017 the Fed would start adjusting its reinvestment policy, with members divided on the precise timing. However, with only half a year left the possible options are limited. TD Economics expects that as long as the economy progresses as expected, the Fed is likely to start the process in the fall, and then raise rates another quarter point in December.
