The minutes of the December FOMC meeting were released today. The minutes were considered to have a dovish tone, although I would be wary of thinking there is much new information to be found. Labor market conditions had improved sufficiently to justify a certain degree of confidence in the inflation outlook:
Regarding the medium-term outlook, inflation was projected to increase gradually as energy prices and prices of non-energy imports stabilized and the labor market strengthened. Overall, taking into account economic developments and the outlook for economic activity and the labor market, the Committee was now reasonably confident in its expectation that inflation would rise, over the medium term, to its 2 percent objective.
but many members retained concerns about the downside risks:
However, for some members, the risks attending their inflation forecasts remained considerable. Among those risks was the possibility that additional downward shocks to prices of oil and other commodities or a sustained rise in the exchange value of the dollar could delay or diminish the expected upturn in inflation. A couple also worried that a further strengthening of the labor market might not prove sufficient to offset the downward pressures from global disinflationary forces. And several expressed unease with indications that inflation expectations may have moved down slightly. In view of these risks and the shortfall of inflation from 2 percent, members expressed their intention to carefully monitor actual and expected progress toward the Committee's inflation goal.
Why hike rates? It is all about setting the stage for a gradual path of subsequent rates hikes:
If the Committee waited to begin removing accommodation until it was closer to achieving its dual-mandate objectives, it might need to tighten policy abruptly, which could risk disrupting economic activity.
And while they ultimately pulled the trigger on higher rates in an unanimous vote, the doves were left with a bitter taste in their mouths:
However, some members said that their decision to raise the target range was a close call, particularly given the uncertainty about inflation dynamics, and emphasized the need to monitor the progress of inflation closely.
They intend to hold true to their "gradualist" scripture:
Based on their current forecasts for economic activity, the labor market, and inflation, as well as their expectation that the neutral short-term real interest rate will rise slowly over the next few years, members expected economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate.
Actual outcomes are of course data dependent, but the Fed called out one piece of data as especially important:
In the current situation, because of their significant concern about still-low readings on actual inflation and the uncertainty and risks present in the inflation outlook, they agreed to indicate that the Committee would carefully monitor actual and expected progress toward its inflation goal. In determining the size and timing of further adjustments to monetary policy, some members emphasized the importance of confirming that inflation would rise as projected and of maintaining the credibility of the Committee's inflation objective. Based on their current economic outlook, they continued to anticipate that the federal funds rate was likely to remain, for some time, below levels that the Committee expected to prevail in the longer run.
Yes, this line from the December statement was not to be ignored:
In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal.
So we now know pretty much what we did going into the minutes: The inflation situation is making FOMC members nervous and thus holding them back from a more aggressive path of rate hikes. Hence progress on the inflation mandate is necessary to accelerate the pace of rate increases. Note too the emphasis on not just actual, but expected progress. That is where the labor report comes in. If jobs keep growing at 200k a month in the first part of the year, the unemployment rate pushes toward 4.5%, and wage growth accelerates, they will will compelled to raise rates further. Actual progress on inflation would accelerate that timeline.
And that is how you get to Vice Chair Stanley Fischer's CNBC comments today:
"We watch what the market thinks, but we can't be led by what the market thinks," Fischer told CNBC's "Squawk Box." He added that market expectations of the number of future rate hikes are "too low."
Fischer expects four rate hikes this year. But that is a data dependent forecast. Financial markets have a different forecast. It is worth recognizing that when it comes to forecasting the path of short rates, financial markets have had something of an upper hand of late.
Separately, ISM services came in below consensus but remains within a solid range. Internals pointed to rising orders and employment as well. It remains a story of two economies: The trade deficit narrowed slightly in November, modestly boosting tracking indicators for fourth quarter GDP. And the ADP numbers game in at a solid 257k December increase in private payrolls, raising expectations for the actual employment release Friday. Consensus is 200k for nonfarm payrolls. I am taking the over.
Bottom Line: Financial markets are stumbling into the new year. The Fed is sticking to its story. Given that January is off the table for a rate hike, we have two and a half months of data - including three employment reports! - to see if the Fed has it right this time.
