When Fed Chair Janet Yellen's testifies before Congress starting Tuesday, she is likely to say that a June hike is still on the table, though not a done deal. To better understand the gulf between Federal Reserve expectations and market expectations, I scanned the last FOMC minutes for the phrase "many participants" to better get a big picture of the Fed`s consensus view of monetary policy. My analysis is based on the interpretation that the "many participants" phrase is more or less representative of the consensus on the FOMC.
First, there was much discussion over the use of RPP for the process of monetary policy normalization, which I won't quote as they do not pertain to the timing of rate hikes, which is what the market is mostly focused on.
Beyond those discussions, there was much concern about the threat slower growth from foreign sources, though I believed that they were focused on the wrong factors (see The key tail-risk that the FOMC missed (and you should pay attention to)). There was, however, disagreement about the level of risk:
Many participants continued to judge that a deterioration in the foreign economic situation could pose downside risks to the outlook for U.S. economic growth. Several saw those risks as having diminished over the intermeeting period, with lower oil prices and actions of foreign central banks both being supportive of growth abroad, but others pointed to heightened geopolitical and other risks.One of the key quote of the signs of Fed dovishness was the reluctance to raise rates, though "some", namely the hawks, were getting antsy:
Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time. Some observed that, even with these risks taken into consideration, the federal funds rate may have already been kept at its lower bound for a sufficient length of time, and that it might be appropriate to begin policy firming in the near term.Another of the key money quotes that the market focused on in the FOMC minutes was the degree of hesitancy over the timing of rate hikes. In addition, note the concerns expressed by "some participants" and "a few" over Fed communication policy (emphasis added):
In connection with the risks associated with an early start to policy normalization, many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the Committee's objectives of maximum employment and 2 percent inflation. In addition, an earlier tightening would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound. Some participants noted the communications challenges associated with the prospect of commencing policy tightening at a time when inflation could be running well below 2 percent, and a few expressed concern that in some circumstances the public could come to question the credibility of the Committee's 2 percent goal. Indeed, one participant recommended that, in light of the outlook for inflation, the Committee consider ways to use its tools to provide more, not less, accommodation.On the trigger points for an interest rate liftoff, it was much like classic pornography definition of "Ill know it when I see it":
Participants discussed the economic conditions that they anticipate will prevail at the time they expect it will be appropriate to begin normalizing policy. There was wide agreement that it would be difficult to specify in advance an exhaustive list of economic indicators and the values that these indicators would need to take.There was wide ranging discussion of what those trigger points are, but the "many participants" consensus was to closely watch inflation and labor market conditions:
Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization. Many participants indicated that such economic conditions would help bolster their confidence in the likelihood of inflation moving toward the Committee's 2 percent objective after the transitory effects of lower energy prices and other factors dissipate. Some participants noted that their confidence in inflation returning to 2 percent would also be bolstered by stable or rising levels of core PCE inflation, or of alternative series, such as trimmed mean or median measures of inflation. A number of participants emphasized that they would need to see either an increase in market-based measures of inflation compensation or evidence that continued low readings on these measures did not constitute grounds for concern. Several participants indicated that signs of improvements in labor compensation would be an important signal, while a few others deemphasized the value of labor compensation data for judging incipient inflation pressures in light of the loose short-run empirical connection between wage and price inflation.Tim Duy believes that there are two key conditions that need to be met before the Fed starts to raise rates. Most importantly, they need to see either rising core inflation, rising expectations of wage inflation, or accelerating wage inflation (emphasis added):
To get a reasonably sized consensus to support a rate hike, two conditions need to be met. One is sufficient progress toward full-employment with the expectation of further progress. I think that condition has already been met. The second condition is confidence that inflation will indeed trend toward target. That condition has not been met. To meet that condition requires at least one of the following sub-conditions: Rising core-inflation, rising market-based measures of inflation compensation, or accelerating wage growth. If any were to occur before June, I suspect it would be the accelerating wage growth.Finally, the Fed recognized that it was boxed in with regard to the "patient" language that had been interpreted by the market as two FOMC meetings and doing so would spook the markets:
Participants discussed the communications challenges associated with signaling, when it becomes appropriate to do so, that policy normalization is likely to begin relatively soon while remaining clear that the Committee's actions would depend on incoming data. Many participants regarded dropping the "patient" language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions. Participants discussed some possible communications by which they might further underscore the data dependency of their decision regarding when to tighten the stance of monetary policy. A number of participants noted that while forward guidance had been a very useful tool under the extraordinary conditions of recent years, as the start of normalization approaches, there would be limits to the specificity that the Committee could provide about its timing. Looking ahead, some participants highlighted the potential benefits of streamlining the Committee's postmeeting statement once normalization has begun. More broadly, it was suggested that the Committee should communicate clearly that policy decisions will be data dependent, and that unanticipated economic developments could therefore warrant a path of the federal funds rate different from that currently expected by investors or policymakers.In summary, a careful read of the FOMC minutes by distinguishing between the phrase "many participants", "some participants" and "a number of participants" can give us a better understanding of how the consensus at the Fed is developing. Indeed, the language of "many participants" is defining market expectations of Federal Reserve monetary policy.
We will have to watch the tone of Janet Yellen's testimony to see how her testimony aligns with the views of "many participants".