The Fed minutes and concerns about the pace of rate hikes

By Edward Harrison On Nov 30, 2018

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I am going to try and make this post brief because want to get out a review of Jonathan Tepper’s wonderful new book, The Myth of Capitalism”. Think of this post as a follow up to my comments on the speeches by Clarida and Powell earlier in the week.

What the Fed thinks about how things are going

Here’s the link to the minutes from the FOMC’s November meeting if you want to look at them yourself. The good thing here is that the minutes conveyed an understanding of the near-term economic outlook that is broadly in line with what I’ve been telling you in recent weeks. And it dovetails with the bullish comments made by Clarida and Powell in their speeches this past week.

Here are a few snippets (with bold added by me for emphasis):

GDP: “The information reviewed for the November 7–8 meeting indicated that labor market conditions continued to strengthen in recent months and that real gross domestic product (GDP) rose at a strong rate in the third quarter, similar to its pace in the first half of the year. Consumer price inflation, as measured by the 12-month percentage change in the price index for personal consumption expenditures (PCE), was 2.0 percent in September.”
Jobs: “Total nonfarm payroll employment increased at a strong pace, on average, in September and October… The unemployment rates for African Americans, Asians, and Hispanics in October were below their levels at the end of the previous expansion. The share of workers employed part time for economic reasons continued to be close to the lows reached in late 2007.
Production: “Industrial production expanded at a solid pace again in September, and indicators for output in the fourth quarter were generally positive… new orders indexes from national and regional manufacturing surveys pointed to solid gains in factory output in the near term.”
Consumption: “Real PCE continued to grow strongly in the third quarter. Overall consumer spending rose steadily in recent months… Key factors that influence consumer spending —including solid gains in real disposable personal income and the effects of earlier increases in equity prices and home values on households’ net worth—continued to be supportive of solid real PCE growth in the near term. Consumer sentiment, as measured by the University of Michigan Surveys of Consumers, remained upbeat in October.”

That’s hugely bullish. But here’s the fly in the ointment: housing

“Real residential investment declined further in the third quarter, likely reflecting a range of factors including the continued effects of rising mortgage interest rates on the affordability of housing. Starts of both new single-family homes and multifamily units decreased last quarter, but building permit issuance for new single-family homes —which tends to be a good indicator of the underlying trend in construction of such homes—was little changed on net. Sales of both new and existing homes declined again in the third quarter, while pending home sales edged up in September

Putting aside the other details in the report, that basically says the situation today looks good on nearly all fronts except housing.

So why is the Fed worried?

There are concerns here though. I’m not talking about financial conditions because the mix of evidence from the minutes says that’s not the real concern here. And Powell’s speech yesterday reinforces this view. So, here’s the part on page 10 expressing the worry. Read it carefully. I like to quote verbatim because sometimes my interpretation could be different than someone else’s. And I think it’s good for you to judge yourself. I have bolded the parts I think are noteworthy.

In their discussion of monetary policy, participants agreed that it would be appropriate to maintain the current target range for the federal funds rate at this meeting. Participants generally judged that the economy had been evolving about as they had anticipated, with economic activity rising at a strong rate, labor market conditions continuing to strengthen, and inflation running at or near the Committee’s longer-run objective. Almost all participants reaffirmed the view that further gradual increases in the target range for the federal funds rate would likely be consistent with sustaining the Committee’s objectives of maximum employment and price stability.

Consistent with their judgment that a gradual approach to policy normalization remained appropriate, almost all participants expressed the view that another increase in the target range for the federal funds rate was likely to be warranted fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations. However, a few participants, while viewing further gradual increases in the target range of the federal funds rate as likely to be appropriate, expressed uncertainty about the timing of such increases. A couple of participants noted that the federal funds rate might currently be near its neutral level and that further increases in the federal funds rate could unduly slow the expansion of economic activity and put downward pressure on inflation and inflation expectations.

Participants emphasized that the Committee’s approach to setting the stance of policy should be importantly guided by incoming data and their implications for the economic outlook. They noted that their expectations for the path of the federal funds rate were based on their current assessment of the economic outlook. Monetary policy was not on a preset course; if incoming information prompted meaningful reassessments of the economic outlook and attendant risks, either to the upside or the downside, their policy outlook would change. Various factors such as the recent tightening in financial conditions, risks in the global outlook, and some signs of slowing in interest-sensitive sectors of the economy on the one hand, and further indicators of tightness in labor markets and possible inflationary pressures, on the other hand, were noted in this context.

My read

Things look good all around right now both in terms of what’s happening on the ground and what the data say about the near-term, say the next few months. The one big exception there is housing.
But because of housing, an interest-sensitive sector, market volatility tightening financial conditions, and bad economic news outside of the US, some FOMC members are concerned the Fed’s guidance is too aggressive. They think the ‘neutral rate’ might be close to where we are right now.
So, the incoming data over the holidays will be very important in informing the Fed if ‘dovish’ FOMC members’ concerns are warranted.
If the data are good, it’s full steam ahead with the present guidance. If the data suck, the Fed will guide toward a slower rate hike path

My takeaway here is that my read of Powell and Clarida was correct. But, what’s notable here regarding the so-called neutral rate is that some FOMC members do think we should be done soon. There are some people at the FOMC meetings who are pushing the view that — if the data remain softer – we should get two more hikes and then decelerate from there. We might even stop altogether. I think this is a minority view though. The question is who has this view and how much influence do they have on the Fed’s committee. Judging from statements by the Chair and the Vice Chair, they are not the ones pushing this view. They seem more optimistic about the rate path guidance.

Overall, I think the minutes serve t put us on notice that the next data sets are make or break regarding where interest rate policy is headed. Good holiday sales numbers will go a long way toward confirming the Fed’s existing rate path. But if those numbers end up being weak, there is now a higher likelihood the Fed will push back its rate hike timetable.

P.S. – Just a reminder that this post is coming to you on email via my new platform on Substack. I hope this works!