FOMC Minutes Emphasize Patience, Some Increase in Downside Risks

The minutes of the December FOMC meeting portrayed a relatively steady view of the growth outlook. However, participants noted the contrast between the strong economic data and concerns from financial markets and business contacts, with several participants mentioning that downside risks had increased. Participants acknowledged that financial conditions had tightened, leading some to downgrade their growth forecasts. The inflation discussion was dovish at the margin, with participants acknowledging lower inflation breakevens as well as reports and surveys suggesting “some moderation in inflation pressure.”

MAIN POINTS is below :

1. According to the minutes of the December FOMC meeting, participants “generally” agreed that the economy was evolving “about as anticipated,” with strong growth and further strengthening of labor markets. However, participants noted the contrast between the strong economic data and concerns about downside risks from financial markets and business contacts. Participants “generally” indicated little change in their growth outlook given a downward revision on the appropriate path for monetary policy, while participants who downgraded their growth forecasts pointed to factors such as financial market developments and the global growth outlook. Contacts in a “number” of Districts appeared less upbeat than in November. Participants generally agreed that risks to the outlook appeared “roughly balanced,” but “some” noted that downside risks had increased. Downside risks included a sharper-than-expected slowdown in global growth, a more rapid waning of fiscal stimulus, an escalation in trade tensions, further tightening of financial conditions, and greater-than-expected effects from monetary policy tightening.

2. Participants again observed that core inflation “remained near 2 percent,” but they added that it had “edged lower.” And while labor markets had “remained strong” and contacts continued to report “tight” labor markets, reports and surveys suggested “some moderation in inflation pressure.” Additionally, “several” participants noted that TIPS inflation compensation had “declined notably” and “a few” thought that longer-run inflation expectations may have indeed “edged lower.” In contrast, participants’ wage growth characterization was little changed, acknowledging the uptrend to a pace “broadly in line” with the economy’s potential. Staff medium-term inflation projections were “little revised on net.”

3. Participants acknowledged that financial conditions had tightened and markets were “volatile.” “Some” participants mentioned that these developments could reflect an increased focus among market participants on tail risks, and while a “couple” of participants believed that the tightening in financial conditions did not seem to have affected the real economy so far, they were concerned about its future impact. A “couple” participants raised concerns about high debt levels in the nonfinancial corporate sector, especially among riskier firms. Some participants noted the “possible risks” to financial stability from a long period of tight resource utilization.

4. On the policy outlook, participants “generally judged” that “some further gradual increases” in the funds rate was appropriate. However, the funds rate was “at or close to the lower end” of the neutral range, and participants noted that recent volatility in financial markets had made the “extent and timing” of future hikes “less clear.” “Many” participants therefore believed that they could be “patient” on future hikes. Participants again sought to emphasize that policy was data dependent, “not on a preset course,” and that the pace and “ultimate endpoint” of future increases were both uncertain. In this vein, “several” participants believed that forward guidance should be removed and replaced with language on data dependence “over upcoming meetings.” A key change in the policy guidance language in the December postmeeting statement—from “expects that further gradual increases” to “judges that some further gradual increases”—was made to “better convey” the FOMC’s data dependency and their judgment that a “relatively limited” amount of additional hiking was appropriate.

5. The Committee also discussed several longer-run issues related to the balance sheet at the December meeting. With regard to the longer-run composition, “several” participants raised the possibility of eventually shifting the balance sheet toward shorter-maturity assets in order to provide the ability to ease by lengthening the maturity structure in a downturn, as well as the possibility of eventually implementing “very gradual” MBS sales in order to return the balance sheet to a mostly Treasury composition. Both ideas have been suggested before, and neither would happen until sometime after the balance sheet reaches its terminal size.

While participants generally viewed “some” further increase in the funds rate as appropriate, they emphasized both patience as well as data dependence for any future hikes, with some participants noting that language on forward guidance should be removed over upcoming meetings. We left our subjective odds of a March hike unchanged at 10%.