Yes, the minutes from April suggested that “most” participants were ready for a June rate hike contingent on strengthening labor market conditions and inflation “progressing” toward two percent, but May’s payroll report and the outcome of the referendum in the U.K. seem to have dampened prospects not only for a rate hike in H2 2016, but also for any hike in H1 2017. Here are some take-aways from the June meeting, but because 1) it was conducted a week prior to the Brexit vote and 2) the new economic growth projections were released immediately following the meeting’s conclusion on June 15th, the minutes are perhaps a bit less relevant than usual.
Interpreting May’s weak payroll figures
“Almost all participants judged that the surprisingly weak May employment report increased their uncertainty about the outlook for the labor market. Even so, many remarked that they were reluctant to change their outlook materially based on one economic data release.” With some participants noting that “labor market conditions [were] at or near those consistent with maximum employment,” it’s not altogether unlikely that future payroll gains will slow. Nonetheless, the increase in uncertainty is one reason that this Friday’s payroll release for the month of June will take on an elevated level of importance.
“Recurring bouts of global financial market instability remained a risk.”
An understatement, to say the least. “Most participants noted that the upcoming British referendum on membership in the European Union could generate financial market turbulence that could adversely affect domestic economic performance.” Surprisingly few details on the risks surrounding a British decision to leave the EU accompanied the minutes, although the minutes did reflect the fact that “the upcoming U.K. referendum on membership in the European Union” was “an additional factor in the Committee's policy deliberations.” Members noted “the considerable uncertainty about the outcome of the vote and its potential economic and financial market consequences [and]… indicated that they would closely monitor developments associated with the referendum as well as other global economic and financial developments that could affect the U.S. outlook.” The main impact to the U.S. to date has been a dramatic decline in Treasury yields as well as a strengthening in the dollar’s value against the British pound, and to a lesser extent, the euro. While lower yields could result in easier financial conditions if credit spreads remain unchanged (all things being equal, which could necessitate an increase in policy rates), a stronger dollar could result in lower import price inflation, potentially shifting the prospect of reaching the Fed’s two percent inflation target even further out into the future. (Similarly, given weaker growth prospects abroad, larger trade deficits remain real possibilities, which could weigh on U.S. growth as well.)
It’s not just the data, but the risks to the data.
Perhaps in a post-Brexit world the Fed wants to proceed a bit more cautiously, but the bar appears to be higher for a future hike than it was in the past. “A couple of members underscored that they would need to accumulate sufficient evidence to increase their confidence that economic growth was strong enough to withstand a possible downward shock to demand.” It’s not just more confidence that’s needed about the labor market and the outlook for inflation, but information around growth as well as the risks around such information. “[Members] judged it appropriate to continue to leave their policy options open and maintain the flexibility to adjust the stance of policy based on how incoming information affected the Committee's assessment of the outlook for economic activity, the labor market, and inflation as well as the risks to the outlook.”
Note the general criticism on the Fed’s communications from…the Fed.
“Several participants expressed concern that the Committee's communications had not been fully effective in informing the public how incoming information affected the Committee's view of the economic outlook, its degree of confidence in the outlook, or the implications for the trajectory of monetary policy.” Perhaps Bank of England Governor Mark Carney’s frequent communications (and subsequent Q&A sessions) will become a model for the Fed?
What to watch
“Members generally agreed that, before assessing whether another step in removing monetary accommodation was warranted, it was prudent to wait for additional data regarding labor market conditions as well as information that would allow them to assess the consequences of the U.K. vote for global financial conditions and the U.S. economic outlook.”
Away from the impact of the U.K vote and the future growth of payrolls, what else will be on the Fed’s watch-list for the remaining four policy meetings this year (three of which occur prior to the presidential election)?
- Spending. Is a slowdown in employment a harbinger of a slowdown in spending? Participants noted that “ financial conditions were accommodative and household balance sheets had improved”—both measures that should support consumption in the months ahead.
- Inflation. Is it set to rise (as evidenced by a pick-up in wage growth, ongoing tightening of resource utilization, and firming in oil prices) or will progress toward two percent be slow (given “persistent disinflationary pressures from very low inflation…[and] weak economic growth abroad.”
- Investment spending. Weakness in capital expenditures has been one of the more puzzling parts of the recovery. Cited as potential drags on spending: “a slowdown in corporate profits, concern about prospects for economic growth, [and] heightened uncertainty regarding the future course of domestic regulatory and fiscal policies.” Whether or not “the sluggishness in business investment could portend a broader economic slowdown” remains to be seen.
- Factors affecting the neutral rate. The neutral rate—the federal funds rate consistent with maintaining trend economic growth—“appeared to be lower currently or was likely to be lower in the longer run than [the participants] had estimated earlier.” While “the Committee could better gauge the effects of increases in the federal funds rate on the economy if it proceeded gradually in adjusting policy,” the extent to which the longer-run neutral rate is lower than historical standards will be a function of “factors such as slow productivity growth and demographic trends.”
- China and the ensuing risks to financial stability. “Some also noted that continued uncertainty regarding the outlook for China's foreign exchange policy and the relatively high levels of debt in China and some other EMEs [emerging market economies] represented appreciable risks to global financial stability and economic performance.”
Next up: the Federal Open Market Committee meeting on Tuesday and Wednesday, July 26 and 27, 2016.