What’s in the Minutes?

What’s in the Minutes?
Bob Eisenbeis
Cumberland Advisors, October 13, 2014

Bob Eisenbeis is Cumberland’s Vice Chairman & Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com.  He may be reached at Bob.Eisenbeis@cumber.com.

Markets reacted positively to release of the latest FOMC minutes on Wednesday, erasing the previous day’s significant losses. However, that reaction was abruptly reversed on Thursday and Friday, reflecting a number of domestic and international concerns, and perhaps signaling a new era of volatility.

The  explanation Thursday for the market’s positive reaction was that market participants interpreted the minutes as suggesting that the first rate hikes might occur later in 2015 than was generally inferred after the release of the FOMC’s statement following its September 16-17 meeting. The seesaw reactions to the timing of a possible policy move, however, reveal more than anything else the market’s skittishness about when and what the Fed will do They tell us considerably less about any rational dissection of the information that Chair Yellen provided in the press conference or about any able parsing of subsequent statements by FOMC participants, taking into consideration who is making the statements and who votes. For example, Bloomberg reporters hyped President Fisher’s statements about a possible move in March 2015. Three facts were ignored, however, in interpreting his remarks. First, his view is not new, and he has been very consistent in his position. He believes that the FOMC went too far with its zero-interest-rate policy and would favor a prompt return to a more normal policy stance. Second, in an interview on Bloomberg he carefully suggested that his personal preference would be for a rate move in March, but he didn’t suggest that this was the consensus view of the Committee. Again, there is no surprise or news there. Finally, he has announced his retirement next April and thus would be a non-voting FOMC participant next year

In commenting on the minutes, much attention has been given to how the Committee appeared to react to international developments, and in particular, to the slowdown in Europe and appreciation of the dollar. These were seen by participants as potentially exerting a drag on US growth due to a slowdown in demand for US goods in Europe and elsewhere and the moderating effects that the appreciation of the dollar would have on inflation by lowering the cost of goods. These points were emphasized by President Dudley in an October 7 speech on the economy.  How much weight will be given to these concerns remains to be seen, but the facts are that the two major US trading partners are Canada and Mexico, so small movements in demand from Europe result in only basis-point movements in the US trade balance and GDP growth. The same is true for the impact of exchange rates on inflation. Again, there is little news on that front with regard to the likelihood of a change in the policy rate.

However, President Dudley went on to add to the confusion by suggesting that mid-2015 rate change was a reasonable inference. But he linked that possibility to the FOMC central-tendency fed funds rate forecast (he avoided indicating what his own forecast was).  However, that suggestion looks to be clearly out of step with the more likely views of the voting members of the FOMC, as reflected in the SEP dot chart released after the September FOMC meeting. Consider the following: Six FOMC participants have the federal funds rate range no higher than .75–1% by the end of 2015. Voting next year will be Presidents Evans, Lockhart, Lacker, and Williams. In a speech delivered on October 8, President Evans outlined the factors leading him to urge patience and caution when beginning to remove policy accommodation, while President Lockhart has argued for waiting for the “whites of the eyes” indicating that inflation is clearly a problem before moving rates. President Lacker’s views on policy are well known, while President Willams is likely to be more in the mid-year camp, seeing any rate move as highly contingent upon incoming data as he stated in an October 9 speech.

The most likely case, then, is that before acting on rates a majority of the FOMC, favoring caution, and sensitive to labor market conditions will require a substantial improvement in growth and employment, a reduction in labor market slack, and signs that inflation expectations are likely to become unanchored. That scenario is not embedded in even the most extreme of the scenarios, based upon the range of the SEP forecasts for 2015.

So what else in the FOMC minutes might be worth talking about for a minute? First, the staff once again marked down slightly the estimates for both growth and inflation for the remainder of 2014 and the medium term. Inflation was projected to remain below the Committee’s 2% objective “over the next few years,” while the risks were tilted slightly to the downside. This is not a forecast supportive of a surge in inflation or growth sufficient to warrant a movement in the policy rate by mid-2015.  Keep in mind too that these forecasts are the prime input to FOMC deliberations by the Federal Reserve Board members.  Those five members dominate the voting of the Committee and share a common information set when it comes to economic forecasts.

Second, embedded in the discussion of participants’ views on current market conditions are indications that, according to a recent Survey of Primary Dealers, “considerable odds were placed on the federal funds rate returning to the zero lower bound during the two years following the initial increase in that rate.” Given most economic forecasts, for such a tail event to be given such a weight by the dealers implies that there is growing market doubt that the path to a more normal policy environment will be smooth. This view may be what was behind the recent Citi Market Commentary of October 8, 2014, suggesting that talk of QE4 may be on the horizon, an event that we don’t believe is likely for several reasons, at least for the U.S. First, for another QE to be on the table, the economy would have to sink dramatically, as would inflation. Second, there is growing discomfort about the declining effectiveness of QE.  Finally, more QE would be politically difficult, especially as a presidential election draws near.

A second point to take from the FOMC minutes is that there was a protracted discussion of the differing views on forward guidance, on how that guidance might be restated to more clearly indicate that a future policy move will be contingent upon incoming data, and on what, if any, role forward guidance will play once policy is no longer accommodative and there is less need to use it as a tool to help anchor inflation expectations. What that discussion suggests is that the future structure of FOMC communications is in a state of flux, implying that the newly constituted communications committee has its work cut out for it both in crafting any new approach and then devising a strategy for its implementation that doesn’t disrupt markets in the process.  In the meanwhile, the view that increased market volatility will be with us for a while seems well founded.

~~~

Bob Eisenbeis, Vice Chairman & Chief Monetary Economist