Minutes show officials grappling with growing threats from market volatility, China slowdown; inflation concerns
Federal Reserve officials appear increasingly reluctant to raise short-term interest rates at their March policy meeting, and possibly beyond, amid market turbulence, China’s dimmed outlook and indications that inflation could stay at low levels longer than expected.
At the January 26-27 gathering, officials “agreed that uncertainty had increased, and many saw these developments as increasing the downside risks to the outlook,” said the minutes, which were released with their regular three-week lag.
The Fed in January held its benchmark short-term interest rate steady at between 0.25% and 0.5%. The central bank increased that rate by a quarter percentage point in December and penciled in four more rate increases for 2016, driven by a view that inflation would start rising as hiring and the economy continued to expand.
The Fed’s next policy meeting is March 15-16. Traders in futures markets see a 94% chance it won’t raise rates then, an 83% chance it won’t move before midyear and about a 50% chance the Fed won’t move rates at all in 2016, according to the Chicago Mercantile Exchange.
“Inflation is not likely to pick up substantially until the second half of the year,” Patrick Harker, president of the Federal Reserve Bank of Philadelphia, said at the University of Delaware on Tuesday. “It might prove prudent to wait until the inflation data are stronger before we undertake a second rate hike.”
Fed Chairwoman Janet Yellen expressed uncertainty about the outlook in testimony to Congress last week without taking a March move off the table. She did emphasize that Fed policy is not on a set course and would be responsive to new developments.
“If inflation is slower to return to target, monetary policy normalization should be unhurried,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said Tuesday. “A more gradual approach is an appropriate response to headwinds from abroad that slow exports, and financial volatility that raises the cost of funds to many firms.”
Of course nothing is yet set. Markets can quickly reverse and the Fed will have a chance to look at more data on inflation and jobs before making a call next month.
Stock markets have already shown some signs of stabilizing. Moreover, economic data haven’t been all bad. The Federal Reserve Bank of Atlanta estimates economic output is expanding at 2.6% annual rate in the first quarter, up notably from a 0.7% pace in the fourth. Moreover wage growth shows signs of accelerating as the jobless rate falls.
The Fed’s policy statement in January was striking because officials decided not to make a judgment about what they call the “balance of risks” to the economy—whether they believed the economy was likely to perform more poorly than their forecasts or exceed their expectations.
The balance of risks matters because it is an indication of whether they are inclined to raise rates again, hold steady or cut them. Some officials already concluded the economy risked underperforming, but other wanted to withhold judgment. Their unwillingness to make any declaration about the balance of risks underscored their hesitance about raising rates.
“Most [officials] were of the view that there was not yet enough evidence to indicate whether the balance of risks to the medium-term outlook had changed materially, but others judged that recent developments had increased the level of downside risks or that the risks were no longer balanced,” the minutes said.
Peter Hooper, chief economist at Deutsche Bank Securities, said he expected the Fed to lower its growth and inflation forecasts when officials next meet in March. That would be a precursor to moving interest-rate plans into neutral.
Mr. Hooper started the year projecting three Fed rate increases this year. He has now downshifted to one later in the year.
The minutes showed the Fed’s own staff economists saw a risk that economic growth and inflation would underperform expectations and unemployment could be higher than forecast, “mainly reflecting the greater uncertainty about global economic prospects and the financial market turbulence in the United States and abroad.”
Expected inflation is an important wild card. Bond-market measures and survey measures of expected future inflation are dropping. Fed officials don’t want to see inflation expectations drift lower. Inflation has already been running below the Fed’s 2% target for more than 3½ years.
Further declines in inflation expectations indicate investors and households might be losing confidence in the central bank’s ability to drive inflation up to target. Undershooting it is an indication of an economy’s lack of vitality, like low blood pressure in a hospital patient.
“A number of participants indicated that, in light of recent developments, they viewed the outlook for inflation as somewhat more uncertain or saw the risks as being to the downside,” the minutes said. “Several participants reiterated the importance of monitoring inflation developments closely to confirm that inflation was evolving along the path anticipated” by the Fed.
The Fed used the word “uncertain” or “uncertainty” 14 times in the January minutes, compared to seven times in December when the central bank raised rates, and six times in October when it telegraphed that a rate increase could be coming.