A lot of discussion but very little concluded

The minutes from the April FOMC meeting show that the committee is having discussions on several important topics currently and that firm conclusions have so far not been reached. These include details in policy normalisation, the extent of transitory effects driving weakness in Q1 growth, communication ahead of the first rate hike, market reaction to lift-off and the level of the natural real Fed funds rate. Also, once lift-off is done, the minutes indicate that the FOMC will be very sensitive to financial market reaction. If we see a new ‘taper tantrum’ spike in rates, this will likely slow the pace of future rate hikes.

The Committee discussed to what extent the weakness in Q1 growth was transitory. A number of reasons were advanced for believing that the weakness in spending observed during the first quarter was partly or even largely transitory. But Various reasons were also advanced for believing that some of the recent weakness in the pace of economic activity might persist. In conclusion however, only a few indicated that downside risks to the economic outlook had risen since the March meeting, while most participants continued to see the risks to the outlook for economic growth and the labor market as nearly balanced. A few members expected that it would be appropriate to raise the Fed funds rate in June but many participants thought it unlikely that the data available in June would provide sufficient confirmation that the conditions for raising the target range for the federal funds rate had been satisfied. We continue to expect a first rate hike in September this year.

Participants also discussed the risks to financial markets from raising the Fed funds rate. Some participants noted the possibility that, at the time when the Committee decides to begin policy firming, term premiums could rise sharply--in a manner similar to the increase observed in the spring and summer of 2013--which might drive longer-term interest rates higher. The Committee also agreed that they would have more frequent updates from the staff on financial market developments in the period after the first rate hike. This is in line with recent comments from Yellen and Dudley in which they mention that market volatility around the first rate hike is expected to increase. In our view, the FOMC is likely to try to test the market reaction to lift-off by verbal intervention ahead of the first hike. It was also discussed whether it would be helpful to pre-announce the first hike, but this was generally not supported. Instead, the participants thought that the wording on the economic developments in the FOMC statement would be enough for markets to determine when the first hike would come.

The level of the equilibrium real Fed funds rate and the uncertainty on such estimates was discussed. A few participants suggested more accommodation might be the right thing on the basis of the low level of the equilibrium real rate and one participant suggested that it might be beneficial to increase the inflation target. There was, however, no general support within the FOMC for these views.

In terms of policy normalisation, one participant suggested that the spread between the top end of the Fed funds rate target range and the rate on primary credit should be increased, but this was generally not supported by the rest of the FOMC.