Instant Analysis: December FOMC Minutes
Despite the quarter point Fed funds rate hike that occurred at the end of the December FOMC meeting, the minutes of that meeting, released today, reveal the dovish tilt that was already beginning to influence the FOMC’s view of the likely extent and timing of further interest rate hikes. The minutes noted that, “Fed officials saw the extent and timing of future hikes as less clear.”
Participants noted the “contrast between the strength of incoming data on economic activity and the concerns about downside risks evident in the financial markets and in reports from business contacts.” Participants generally revised down their individual assessments of the appropriate path for monetary policy, but indicated little or no material change in their assessment of the economic outlook.
Financial market developments, including equity price declines, corporate credit spread widening, and Treasury yield curve flattening, clearly rattled some nerves on the FOMC about the economic outlook. “Some participants commented that these developments may reflect an increased focus among market participants on tail risks such as a sharp escalation of trade tensions or could be a signal of a significant slowdown in the pace of economic growth in the future.”
Parsing the minutes, it is clear the evolution of U.S. inflation outlook will be a key determinate in forecasting future FOMC rate hikes. A few participants noted the recent decline in energy prices would likely only temporarily weigh on headline inflation. However, “Several participants remarked that longer-term TIPS-based inflation compensation had declined notably since November, suggesting to a few participants that longer-run inflation expectations may have edged lower.” While several others cited survey-based measures that show longer-run inflation expectations remain well-anchored. Overall, many officials felt the Fed could be patient in further rate hikes, especially in an environment of muted inflation pressures.
The Fed was trying to convey in the statement that they were more cautious on the interest rate outlook than in September, and that there was likely a relatively limited amount of additional tightening ahead. While most FOMC members still saw upside and downside risks to the economic outlook as balanced, there were a number of important downside risks that were discussed, including a sharper than expected decline in global growth, fading fiscal stimulus, heightened trade tensions, further tightening of financial conditions, and negative impacts from the monetary policy tightening to date.
Financial market action today is in line with the dovish tilt to the December FOMC minutes and a slower FOMC rate hike path ahead. Stocks ended the day modestly higher, while Treasury bond yields generally fell with bigger declines seen at the shorter-end of the curve. The Fed funds futures market is currently pricing in a 19.4% probability of a June rate hike down from a 26.5% probability priced in yesterday. The U.S. dollar also dropped 0.76% today as lower U.S. interest rates get factored into global currency markets. We are currently forecasting only one Fed rate hike this year at the June FOMC meeting. We believe slowing consumer inflation over the near-term, from the drop in energy and commodity prices, gives the FOMC room to pause for a while longer to ascertain the true message of the deterioration in financial market conditions and the longer-term impact on the economic and inflation outlook. But we haven’t altered our view that economic growth in the United States is likely to remain above potential over the first half of 2019.