FOMC: January minutes highlight importance of financial conditions - Westpac

The minutes of the January FOMC meeting make clear that “gradual” remains the operative word for policy, explains Elliot Clarke, Research Analyst at Westpac.

Key Quotes

“Clear in this communication was greater optimism over the outlook for the labour market and growth, but also a reluctance to believe that activity momentum will translate into a material lift in wage and consumer inflation. At January, the risks were seen as balanced.”

“Beginning first with activity. Recent data was believed to be consistent “with continued above-trend economic growth and a further strengthening in labor market conditions”. 
On business investment, “Participants characterized their business contacts as generally upbeat about the economy”, though “several participants expressed considerable uncertainty about the degree to which changes to corporate taxes would support business investment and capacity expansion”. This caveat arguably is as much to do with the timing of new activity as it is the eventual scale of this investment.”

“For households, the focus was on the willingness of consumers to spend. Of particular note, “In connection with solid growth in consumer spending, a couple of participants noted that the household saving rate had declined to its lowest level since 2005, likely driven by buoyant consumer sentiment or expectations that the rise in household wealth would be sustained.” Note here the focus is on positive expectations of the future rather than concern over the low level of the savings rate and its ongoing downtrend.”

“The labour market remains the chief support of consumer and FOMC confidence. The January minutes highlighted that underemployment (the U6 measure) has now returned to “pre-recession levels”. Combined with strong employment growth and stable participation, the absence of slack is good reason for households to be positive on their job prospects.”

“That said, there remains “few signs of a broad-based pickup in wage growth”. Caution over the longevity of tax-cut induced pay increases was also raised, “a few participants suggest[ing] that such a boost could be in the form of onetime bonuses or variable pay rather than a permanent increase in wage structures”. The Committee still believes that an absence of slack will win out and see wage growth accelerate, but this will only occur slowly.”

“In the meantime however, financial conditions are offering substantial support. As per the minutes, “Many participants noted that financial conditions had eased significantly over the intermeeting period... the decline in the dollar and the rise in equity prices... more than offsetting the effects of the increase in nominal Treasury yields”.”

“That financial conditions have eased at a time when the FOMC is tightening policy will grant confidence that downside risks associated with further gradual rate increases and quantitative tightening are negligible. More to the point, this implies that risks to the FOMC rate view (and our own) are arguably to the upside.”

“The equity market correction of early February notwithstanding, since the January FOMC meeting, we have seen a further significant increase in government spending (1.5% of GDP in the 18 months to September 2019) and signs of stronger wages. On consumer inflation, the January CPI print will have also given the FOMC greater cause for confidence that inflation disappointment is behind them and that the risks are instead skewed to inflation at or moderately above target.”

“In these circumstances, a continued ‘gradual’ increase in the fed funds rate through 2018 and 2019 (five hikes in total) is still the best base case. However, a careful eye will need to remain on financial conditions. Should they continue to move in the opposite direction to policy, a more concerted effort by the FOMC may prove necessary to keep the economy on an even footing.”