https://www.federalreserve.gov/monetarypolicy/fomcminutes20230920.htm
Commentary
Market participants have once again focused on the “higher for longer” narrative that the Chairman made sure was prominent in the minutes. However, a close reading of the minutes makes clear that a substantial portion of the FOMC is leaving the door open to easing policy at the first signs of weakness. A key aspect of the “door-ajar stance” is that the staff and committee members are overly pessimistic about inflation in the short-run and overly optimistic in the long-run. Indeed, the staff’s expectation of core inflation at 3.5% for year-end is likely to be surpassed on the downside in the October PCE. Participants made clear that signs of banking stress or rapidly declining inflation would be reasons for them to reassess the stance of policy.
The downside concerns that were listed in the minutes were notable because they represented a grab bag of leftist priorities that were surely put on the agenda by the Biden Four. As this writer has discussed often, the FOMC is not a true committee where all votes are equal. The Chairman cannot allow himself to be on the losing side of a vote. In addition, the primary policy vehicle is not the fed funds rate – set by the FOMC – but rather the interest on reserves – set by the Reserve Board. The Biden Four represent a majority on the Board, and therefore get to set the agenda over and above the Chairman’s wishes – Powell has become a mere observer.
Notable at this meeting was that the hawks were the ones left disappointed in the “unanimous” vote. At the July meeting the “unanimous” vote to raise rates included at least two doves who wanted to leave rates unchanged. At the September meeting, the committee elected to pause above the objections of hawks who felt raising rates was prudent. Clearly the downside risk has grown large in the Committee’s collective view, and this was made clear on the last page of the minutes, where the doves got to speak their mind.
This writer continues to expect the Committee to express surprise and concern at the pace of core inflation declines between now and the December meeting. The rapid short-term decline in inflation, along with further banking stress from higher long-term rates will prompt a “tweak” to policy where the committee cuts rates by 25 basis points. However, the Chairman will take great care to emphasize at the press conference that the move is not an easing of policy, but an effort to maintain the stance of policy in the face of higher real interest rates. That will prove to be a grave error as the pipeline for inflation currently indicates the next wave will begin to become apparent in Spring 2024. The Second Great Inflation is upon us.
Staff Review
-- In addressing the increase in nominal yields on longer-run Treasury securities over the intermeeting period, the manager noted that the rise in real yields exceeded that of nominal yields over the period, implying a small decline in inflation compensation. Inflation expectations appeared to remain very well anchored.
-- The economic forecast prepared by the staff for the September FOMC meeting was stronger than the July projection, as consumer and business spending appeared to be more resilient to tight financial conditions than previously expected.
-- In all, the staff projected that real GDP growth in 2024 through 2026 would be slower, on average, than this year and would run below the staff’s estimate of potential output growth, restrained over the next couple of years by the lagged effects of monetary policy actions.
-- Total and core PCE price inflation were forecast to be around 3.5 percent at the end of this year, and inflation was projected to move lower in coming years. Risks around the inflation forecast were seen as skewed to the upside, given the possibility that inflation could prove to be more persistent than expected or that further adverse shocks to supply conditions might occur.
Participants
-- Participants assessed that real GDP had been expanding at a solid pace and had been more resilient than expected. Nevertheless, participants also noted that they expected that real GDP growth would slow in the near term. Participants judged that the current stance of monetary policy was restrictive and that it broadly appeared to be restraining the economy as intended.
-- Participants continued to view a period of below-trend growth in real GDP and some softening in labor market conditions as likely to be needed to bring aggregate demand and aggregate supply into better balance and reduce inflation pressures sufficiently to return inflation to 2 percent over time.
-- Many participants remarked that the finances of some households were coming under pressure amid high inflation and declining savings and that there had been an increasing reliance on credit to finance expenditures. In addition, tighter credit conditions, waning fiscal support for families, and a resumption of student loan payments were viewed by several participants as having the potential to weigh on the growth of consumption.
-- Several participants noted, however, that the tightening of credit conditions resulting from the banking stresses earlier in the year was likely to be less severe than they previously expected. A number of participants expressed concerns about vulnerabilities in the CRE sector.
-- Participants noted that the data received over the past several months generally suggested that inflation was slowing. Participants pointed to the softening of price inflation for goods amid improving supply conditions and to declining housing services inflation.
-- Participants observed that, notwithstanding recent favorable developments, inflation remained well above the Committee’s 2 percent longer-run objective and that elevated inflation was continuing to harm businesses and households—particularly low-income households.
-- Participants stressed that they would need to see more data indicating that inflation pressures were abating to be more confident that inflation was on course to return to 2 percent over time.
-- Various participants noted downside risks to economic activity, including that credit conditions might tighten more than expected if the domestic banking sector experienced further strains; the possibility that the economic slowdown in China could result in a drag on global economic growth; or that an extended U.S. government shutdown could have negative, albeit temporary, consequences for growth.
-- Almost all participants judged it appropriate to maintain the target range for the federal funds rate at 5¼ to 5½ percent at this meeting.
-- A majority of participants judged that one more increase in the target federal funds rate at a future meeting would likely be appropriate, while some judged it likely that no further increases would be warranted.
-- A few participants noted that the pace at which inflation was returning to the Committee’s 2 percent goal would influence their views of the sufficiently restrictive level of the policy rate and how long to keep policy restrictive.
-- A few participants noted that it would be important to monitor the real federal funds rate in gauging the stance of monetary policy over time.
-- A vast majority of participants continued to judge the future path of the economy as highly uncertain. Many noted data volatility and potential data revisions, or the difficulty of estimating the neutral policy rate, as supporting the case for proceeding carefully in determining the extent of additional policy firming that may be appropriate.
-- Many participants commented that even though economic activity had been resilient and the labor market had remained strong, there continued to be downside risks to economic activity and upside risks to the unemployment rate. Such risks included larger-than-anticipated lagged macroeconomic effects from the tightening in financial conditions, the effect of labor union strikes, slowing global growth, and continued weakness in the CRE sector. Participants generally noted that it was important to balance the risk of overtightening against the risk of insufficient tightening.