Federal Reserve Minutes: Keeping the options open

Federal Reserve Chairman Jerome Powell has markets in a bit of a puzzle. What did his comment in a speech to the New York Economic Club that 'Interest rates...remain just below the broad range of estimates of the level that would be neutral for the economy" mean?  Was the Chairman hinting that higher rates are starting to impact the economic expansion and that a pause sometime next year might be in order? Or was he just correcting the opposite impression from early in October when he noted that the Fed Funds rate was probably "a long way from neutral?' 

Mr. Powell's board range for the neutral rate for 2019 should be contained in the central tendency plot for the Fed Funds rate in the September projection materials. That runs from 2.9% to 3.5%.  The upper end of that plot and the rate projection of 3.4% at the end of 2019 encompasses the 0.25% increase in December and the three hikes next year that have been the market standard since the September release, and a Fed Funds rate of 3.5%. The lower border at 2.9% implies two increases, assuming a December hike, one increase next year and a rate of 3%.   

The first place to look for evidence of a change in Fed outlook is the minutes from the November 7-8 FOMC meeting when then committee voted to maintain the Fed Funds target rate at 2.00%-2.25%. The statement from that meeting did observe a change in the economic situation.

In September when it raised the target rate 25 basis points, the FOMC statement said "household spending and business investment have grown strongly."  In November the statement  became "household spending has continued to grow strongly while growth of business fixed investment has moderated from its rapid pace earlier in the year."  That change acknowledges the downshift in third quarter capex which slowed to 0.8% annualized from the previous quarters blistering 8.7% rate. 

Opinions on the US economic outlook differed somewhat in the minutes from the September and November meetings.

The September minutes said that information "indicted that the labor market continued to strengthen and that economic activity rose at a strong rate." November's minutes repeated the wording but changed "rose at a strong rate “to "have been rising at a strong rate."  Job gains were "strong" in both. Unemployment "had declined" in September and "stayed low" in November.  

In September several participants had noted "a pace of economic activity that was stronger than they had expected earlier this year." That reference disappeared in November. Both months cited "above trend growth' but November added “before slowing to a pace closer to trend over the medium term, and "the simulative effect of fiscal policy would likely diminish over time."

Consumer spending was expected to remains strong in September and November.  Labor markets remained tight and shortages might be restraining activity.  September's assertion that "participants generally agreed that risks to the outcome appeared roughly balanced," was gone in November. More references were made in November to the risks and effects of tariff and trade policies and a notice was made by several participants of "the high level of debt in the nonfinancial business sector, and especially the high level of leveraged loans....which could exacerbate the effects of a negative shock on economic activity."

In September "all participants expressed the view that it would be appropriate... [to raise] the target range for the federal funds rate 25 basis points at this meeting."  Two months later the opinion had become "Almost all participants expressed the view that another increase in the target range...was likely to be warranted fairly soon..."  "However, a few participants, while viewing further gradual increases....as likely to be appropriate, expressed uncertainty about the timing of such increases." 

The accommodative stance of the past decade has been put to rest. "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 contex.t"

The governors in their gentle way are noting a change of circumstances. To say that they see trouble ahead would overstate the case, but the tone of the economic picture has shifted. A few warning signs are appearing, it is best to keep the options open.

"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." As always the Fed is data dependent.