Policymakers at the Federal Reserve are increasingly at odds over whether its dual mandate of price stability and maximum employment is close to being met, minutes from the September meeting released on Wednesday showed.
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Last month, the policy-setting Federal Open Market Committee voted in a 7-3 decision to keep short-term interest rates on hold due to perceived labor market slack and an inflation rate that continue to run below the 2% target. Members agreed to wait for further evidence of continued economic improvement, though some worried that postponing a 0.25% rate increase would push the unemployment rate below its longer-run normal rate over the next few years and could cause the central bank to lose credibility over its communications if the gradual removal of accommodative monetary policy were delayed further.
The minutes showed several of the committee’s members viewed the decision as a “close call” as they saw near-term risks to the economic outlook roughly balanced and a strengthening case for raising the target federal funds rate. Still, a few members saw downside risks to raising rates too quickly citing weaker-than-expected growth in overseas economies, ongoing Brexit uncertainty, and persistent headwinds to U.S. growth.
“I was struck by the consistent proclamation that they are looking at economic growth and inflation,” Chuck Self, chief investment officer at iSectors, said. “So much of the talk out in the market has been the economy is recovering, it’s going to be fine in the second half of 2017…but even if it is fine, where’s the inflation?”
The minutes indicated members anticipated headline inflation would rise to around 2% in the medium term, though 12-month core personal consumption expenditures (PCE) held steady just below the objective, at around 1.6%. Further, some expressed concern over factors that could prevent inflation from rising, including limited evidence of increased cost or price pressures, low responsiveness of inflation to labor utilization, lowered inflation expectations, and remaining economic slack.
Some members also worried slow wage growth coupled with the number of involuntary part-time workers in the labor force and increases in the labor force participation rate suggested the longer-run normal unemployment rate was uncertain or could be lower than current expectations.
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“There’s a question of what is maximum employment,” Self explained. “Yes, the unemployment rate got down to 4.9%, but every time that happens, a lot of people come back into the labor market. That’s what happened in the September report last week. It’s not clear where maximum employment is and certainly without wage-growth pressure, the Fed runs the risk of starting back the rate increases too quickly.”
Self said he sees the Fed holding off any interest rate hikes until 2017 as members continue to rely on incoming economic data for further evidence of the health of the U.S. economy. However, Wall Street expectations, as measured by federal funds futures, show about a 70% chance of a rate rise by December. That is perhaps for no better reason than to save face, according to Chris Gaffney, president of World Markets at EverBank.
”The situation is very similar to the one faced in 2015 when members basically backed themselves into a corner by committing to an interest rate increase sometime during the year,” he said. “We all know they felt we would see up to four rate increase in 2016; a position which they have had to backtrack away from all year as the data just doesn’t support higher rates,” he said.
Meanwhile, muted reaction in U.S. equity markets was evidence the September minutes didn’t provide any additional clarity or add to confusion, said Edward Jones investment strategist Kate Warne.
“Some wanted to move relatively soon while others wanted to wait for more convincing evidence of rising inflation. That suggests the dissenting voters weighed the risks differently rather than having dramatically different views,” she said.
Warne believes a cautious and patient Fed creates a positive environment stocks over time.