Minutes from the January FOMC meeting were released today. It is fairly clear that the Fed is gearing up for rates hikes:
Participants discussed considerations related to the choice of the appropriate timing of the initial firming in monetary policy and pace of subsequent rate increases. Ahead of this discussion, the staff gave a presentation that outlined some of the key issues likely to be involved...
The debate sounds familiar. On one side are those concerned that the Fed's zero rate policy will overstay its welcome:
Several participants noted that a late departure could result in the stance of monetary policy becoming excessively accommodative, leading to undesirably high inflation. It was also suggested that maintaining the federal funds rate at its effective lower bound for an extended period or raising it rapidly, if that proved necessary, could adversely affect financial stability...
while on the other side doesn't want to pull the trigger too early:
In connection with the risks associated with an early start to policy normalization, many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the Committee's objectives of maximum employment and 2 percent inflation. In addition, an earlier tightening would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound.
I would say that "many" is greater than "several," which means that as of January, the consensus leaned toward later than sooner. Indeed:
Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time...
Here it would be helpful to know the expected time horizons. How long is a "longer" time? My sense is that the possibility of a March hike was on the table at the request of the hawks, and "longer" meant sometime after March. But when after March? That is data dependent, but the Fed is challenged to describe exactly what conditions need to be met before justifying a rate hike:
Participants discussed the economic conditions that they anticipate will prevail at the time they expect it will be appropriate to begin normalizing policy. There was wide agreement that it would be difficult to specify in advance an exhaustive list of economic indicators and the values that these indicators would need to take.
Still, they have some broad guidelines:
Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization. Many participants indicated that such economic conditions would help bolster their confidence in the likelihood of inflation moving toward the Committee's 2 percent objective after the transitory effects of lower energy prices and other factors dissipate.
It seems then that "many" participants are focused primarily on the labor market. It would be interesting to see how "many" of those "many" saw their confidence increase after the positive January numbers. Others pointed to inflation measures and wages as important indicators:
Some participants noted that their confidence in inflation returning to 2 percent would also be bolstered by stable or rising levels of core PCE inflation, or of alternative series, such as trimmed mean or median measures of inflation. A number of participants emphasized that they would need to see either an increase in market-based measures of inflation compensation or evidence that continued low readings on these measures did not constitute grounds for concern. Several participants indicated that signs of improvements in labor compensation would be an important signal, while a few others deemphasized the value of labor compensation data for judging incipient inflation pressures in light of the loose short-run empirical connection between wage and price inflation.
My take is this: To get a reasonably sized consensus to support a rate hike, two conditions need to be met. One is sufficient progress toward full-employment with the expectation of further progress. I think that condition has already been met. The second condition is confidence that inflation will indeed trend toward target. That condition has not been met. To meet that condition requires at least one of the following sub-conditions: Rising core-inflation, rising market-based measures of inflation compensation, or accelerating wage growth. If any were to occur before June, I suspect it would be the accelerating wage growth.
On communication, the Fed sees that is has trapped itself:
Participants discussed the communications challenges associated with signaling, when it becomes appropriate to do so, that policy normalization is likely to begin relatively soon while remaining clear that the Committee's actions would depend on incoming data. Many participants regarded dropping the "patient" language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions.
If "patient" means exactly two meetings as is widely believed, then why would dropping patient imply higher rates in an "unduly narrow range of dates"? Isn't "two" two? If "two" is two, why the need for the adjective "unduly"? The definition of "unduly" according to the dictionary is:
to an extreme, unreasonable, or unnecessary degree
So "two" is thus extreme or unreasonable? Either "two" isn't two or patient wasn't meant to imply always two meetings. Indeed, Cleveland Federal Reserve President Loretta Mester suggests that "two" is only one interpretation. Via the Wall Street Journal:
WSJ: When you say that, do you have April in mind or do you have June in mind?
MESTER: Given what we’ve communicated, June is a viable date. We have the patient language which has been interpreted as two meetings.
The language "has been interpreted" not "means" two meetings. If "two" is plainly two, how can it have any other interpretation? And "has been interpreted" by whom, for that matter?
You get the point. The Fed can't keep itself from making calendar dependent statements, and thus undermines it's own communications. Yellen should have said "patient" means "until the data says otherwise." But she couldn't help herself by not including some kind of calendar dependent qualifier. As a consequence, now the Fed is stuck with modifying the language to keep a June rate hike on the table.
Wait, is a June rate hike still on the table? Although the minutes were interpreted dovishly by financial market participants, I doubt the Fed will want to pull the plug on June just yet. Incoming Fed speak continues to signal a rate hike is coming (including Mester describing June as a "viable option" this week), the January labor report was solid, via the minutes the Fed sees external risks as dissipating, we have four more employment reports before the June meeting, and I doubt the Fed really wants to start signaling policy two periods in advance. Too early to pull June off the table, but they can't move in June without something solid on the inflation front. So the March statement, or subsequent press conference, will be about dealing with the "patient" language, and the April meeting will be about whether they really expect to move in June or not.
One more consideration. It has been noted that the length of the minutes ballooned in January. Less noted is that the FOMC has a new secretary, Thomas Laubach, who succeeds William English. The additional detail may reflect that change, and the additional detail may swing our interpretation of the minutes relative to past minutes.
Bottom Line: The Fed is plainly focused on raising rates. As a group, they sense the time is coming to begin policy normalization. But they don't yet know when exactly that time will be. They don't yet have everything they need to begin, and they don't know when they will have everything (which is why they need to end calendar-dependent language). We know not yet. June? Maybe, maybe not.