December FOMC Minutes: Three areas to examine – Nomura

The FOMC minutes released throughout 2017 were informative, revealing in the first half of the year the discussions and plans for the Fed’s balance sheet unwind, explains the research team at Nomura.

Key Quotes

“More recently, the minutes have provided valuable insights into the Committee’s thinking (and diverse views) on inflation, financial conditions and risks. For the 12-13 December meeting minutes scheduled to be released today, our attention will focus on three areas: inflation, labor markets and fiscal policy.”

“Inflation

• Reflecting Chair Yellen’s reiteration that she and the FOMC do not fully understand the recent underperformance of inflation, we expect the minutes from December to largely mimic the inflation discussion from the 31 October-1 November meeting minutes. There, “several” participants referenced possible issues with the link between resource utilization and inflation, while “a few” mentioned technological innovation as a possible cause. Given the dissent from Evans and Kashkari during the December meeting, partly owing to inflation concerns, another discussion of the risks of too-low inflation and declining inflation expectations is likely.
• Finally, comments in the Oct/Nov meeting minutes from “a couple” of participants on alternative frameworks for monetary policy, including price level targeting, could show up again in the December meeting minutes, although we continue to view this as a longer-term issue that the Committee is unlikely to take up any time soon. Overall, while the subdued inflation readings in 2017 remain a mystery for the FOMC, we expect that the December inflation discussion will reflect the Committee’s continued confidence in inflation gradually picking up to its 2% objective.
• The minutes may also reveal increased concern over upside inflation surprises stemming from an improving outlook for labor markets.”

“Labor markets

• Relative to November, the December statement modified the expectation of labor markets from “strengthen somewhat further” to “remain strong.” As Chair Yellen noted in the press conference, “This change highlights that the committee expects the labor market to remain strong, with sustained job creation, ample opportunities for workers and rising wages.” Consistent with these statements, the December SEP forecast for the unemployment rate shifted downwards for 2018, 2019, and 2020, from the September SEP forecasts. For 2019, for instance, the median unemployment rate forecast fell 0.2pp to 3.9%, a forecast we think is still too high (our forecast is for 3.5% by the end of 2019).
• The minutes may reveal more participants expressing concern about the pace of improvement in labor markets, highlighting the risk of falling too far behind the curve. In the press conference, Chair Yellen stated that, “Allowing the labor market to overheat would raise the risk that monetary policy would need to tighten abruptly at a later stage, jeopardizing the economic expansion.” Therefore, markets may view the language in the minutes about labor markets as hawkish while, in our view, the modification to the FOMC’s outlook on labor market conditions in the December statement may have been to emphasize that the labor market part of the dual mandate has mostly been achieved.
• In line with the FOMC’s expectations, incoming data point to continued strength in the labor market. We expect the December employment report, which will be released on Friday, to show another month of solid nonfarm payroll job gains (190k) and a decline in the unemployment rate to 4.0%, from 4.1%.”

“Fiscal policy

• When it comes to fiscal policy, most attention has recently focused on the Republican tax plan instead of spending. We expect that to be reflected in the minutes as well, based on Chair Yellen’s press conference where she fielded several questions on tax policy. In one response she stated that tax policy is “one of the reasons I think for the uptick you see in estimated growth and decline in the unemployment rate.”
• However, possible changes in federal spending could significantly boost the 2018 and 2019 economic outlook as well, but we have seen no evidence of this analysis in recent statements by Federal Reserve officials. If the minutes lack a discussion of federal spending, then we would view federal spending as a significant upside risk to Fed policy.”