FOMC Minutes: Officials Expected to Raise Short-Term Rates "Soon" At Last Meeting

By Nick Timiraos Features Dow Jones Newswires

Federal Reserve officials expected at their policy meeting earlier this month that it would "soon be appropriate" to raise short-term interest rates once again, according to minutes of the gathering released Wednesday, a signal the U.S. central bank could lift its benchmark rate at its next gathering in June.

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The Fed also moved toward a consensus on a plan to shrink its $4.5 trillion in holdings of Treasury and mortgage securities later in the year by gradually allowing increasing amounts of those securities to mature without reinvesting them.

Officials were inclined to stick to their plan even though the economy appeared to stumble in the first quarter. That slowdown was seen as transitory, the minutes said. Moreover, some officials expressed concern about recent softness in inflation, but not enough to force them to scrap plans to raise rates twice more this year.

The next meeting is June 13-14, which will be followed by a press conference from Fed Chairwoman Janet Yellen.

"Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the committee to take another step in removing policy accomodation," the minutes said.

Before Wednesday's release of the account of May's meeting, traders in futures markets placed an 83% probability on a Fed rate increase by June, according to CME Group. The minutes are likely to solifidy those expectations.

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Fed officials left their benchmark short-term interest rates unchanged within a range between 0.75% and 1% at the meeting May 2-3. Several Fed officials in recent weeks have said they believe the economy will still be strong enough to warrant two more rate increases this year.

"Although incoming data showed that aggregate spending in the first quarter had been weaker than participants expected, they viewed the slowing as likely to be transitory," the minutes said. Officials expected ongoing job gains, rising household income and wealth and buoyant consumer sentiment to bolster spending in the months ahead. "Participants generally indicated their assessments of the medium term economic outlook had changed little since the March meeting."

With their forecasts stable, officials effectively believed they had a green light to move again.

Inflation has wobbled in recent months, a cause of concern for some officials, but one most were prepared to look past for now. The Fed's preferred inflation gauge, the price index for personal-consumption expenditures, briefly surpassed the Fed's annual 2% target in February but posted a greater than expected drop in March, with annual prices up 1.8%. A separate inflation gauge released since the May meeting, the Labor Department's consumer-price index, also showed a lower trajectory in April. Prices excluding food and energy were up 1.9% on the year, the first time the annual gain in core prices had been below 2% since October 2015.

Officials generally believed the deceleration in price pressures would prove transitory, with inflation stabilizing around 2% over the medium term amid sustained improvement in the labor market. But some officials expressed uncertainty about the greater-than-expected weakness.

Uncertainty around the inflation outlook stands in contrast to labor markets. The April employment report released days after the May meeting showed steady hiring, with an average 185,000 jobs added monthly so far this year, and the unemployment rate fell to 4.4%, at the bottom range of officials' expectations. The rate hasn't been lower since May 2001 and indicates the U.S. is near or at what economists consider full employment, a level that won't stoke an unsustainable surge in wages.

Some officials at the May meeting said stronger hiring and wage gains and larger declines in the unemployment rate could warrant a faster pace of rate increases, but a few officials said the Fed's trajectory could be slower than currently projected if continued declines in the unemployment rate didn't create obvious price pressures.

The central bank's discussion around how to wind down its portfolio, also known as its balance sheet, has picked up because the economy is moving closer to meeting the Fed's goals of steady, low inflation and maximum, sustainable employment. Officials stopped adding to the balance sheet more than three years ago, but they have been reinvesting the proceeds of maturing assets to keep their holdings steady.

A staff briefing on their latest proposals to shrink those holdings would warrant tapering reinvestments of Treasury and mortgage securities by setting limits on the dollar amounts of holdings that could mature every month. The Fed could then increase those limits every three months over time to allow more securities to run off.

The minutes said "nearly all" officials agreed with the approach spelled out in the May briefing.

Officials have indicated they may prefer to reduce the balance sheet by tapering the reinvestments in order to let those holdings shrink in a gradual and predictable way. They want to avoid a rerun of the 2013 "taper tantrum," when investor concerns over the Fed's decision to slow the pace of those asset purchases roiled markets, leading to a large spike in Treasury yields and capital outflows from emerging market economies.

Under the emerging scenario Fed officials have outlined in public speeches and interviews, the central bank would raise short-term interest rates two more times this year and then pause rate increases later in the year when they announce plans to set their balance-sheet wind-down into motion. A pause would allow the Fed to watch for any ill-effects before resuming rate increases in 2018.

Philadelphia Fed President Patrick Harker said Tuesday the process of shrinking the Fed's balance sheet should be predictable and boring with lots of advance notice to markets, like "the policy equivalent of watching paint dry," he said.

(END) Dow Jones Newswires

May 24, 2017 14:15 ET (18:15 GMT)