A discussion about how high US interest rates should go in this tightening cycle could feature prominently in the release of minutes later this week of the Federal Reserve’s June 12-13 policy meeting.
The record may also show officials debated the risks posed by a mounting dispute between the US and key trading partners, a stronger dollar and the flattening yield curve, concerns that could damp expectations for a faster pace of rate increases. The minutes will be released at 2 p.m. in Washington on Thursday.
Chairman Jerome Powell, in his post-meeting press conference, poured cold water on the idea that policy makers can precisely measure the level at which rates would have a neutral impact on the economy — a key to deciding when to stop hiking. But that wouldn’t have halted the discussion among policy makers, according to Joseph Song, senior U.S. economist at Bank of America Corp.
“It’s still something they’ll try to estimate, and still something that’s important for the path of policy,” Song said. “Knowing that range of estimates is significant, and whether the Fed believes it can get above that level.”
With unemployment falling to the lowest level since 2000 and inflation back up to their 2 percent target, officials raised the target range for the benchmark federal funds rate to 1.75 percent to 2 percent and released new forecasts at their meeting last month.
In those, the Federal Open Market Committee’s median projection for the number of rate hikes in 2018 moved up to four from three, though the move was driven by just one unidentified official changing his or her projection. The estimate for neutral was unchanged at 2.9 percent.
The minutes “might take a little of the hawkish air out of the June” projections, Song said.
Whether the Fed moves one or two more times in 2018 could hinge on actual inflation readings and inflation expectations. The past two Fed statements added an extra reference to the central bank’s “symmetric” inflation target, an addition seen by many as a signal policy makers would tolerate inflation slightly above their goal.
The Fed’s preferred gauge of annual price gains hit 2.3 percent in May. Though the meeting occurred before that inflation data was available, Gus Faucher, chief economist at PNC Financial Services Group Inc. in Pittsburgh, said the minutes may provide some signal on how Fed officials would react to higher inflation.
“They made a big point in emphasizing the symmetry of their inflation goal,” Faucher said. “How high are they willing to let inflation get? When do they start to worry.”
Fed watchers are also keen for more information on how officials are gauging the impact of escalating tensions over trade, driven by the Trump administration’s imposition of new tariffs and subsequent reactions from China, the European Union and other countries.
“The baseline hasn’t been impacted much — the impact on U.S. growth,” Faucher said. “That could change as we get more concrete tariffs and retaliation from trading partners and the cost becomes more apparent.”
Speaking since the FOMC meting, several officials have said the threat of a deepening conflict had begun to affect the investment and hiring decisions of U.S. firms. “Changes in trade policy could cause us to have to question the outlook,” Powell said June 20 in Portugal.
A stronger dollar might also make policy makers reconsider their forecasts. The Bloomberg Dollar Spot Index, which tracks the greenback against a basket of leading global currencies, has appreciated around 6 percent since mid-April.
The stronger dollar can mute inflation by making imports cheaper. It can also curb growth by hurting exports, an impact seen by economists as more persistent and consequential.
“That’s something that would push back on any expectations for faster rate hikes,” said Luke Tilley, chief economist at money manager Wilmington Trust Corp. and a former Philadelphia Fed staffer.
Then there’s the yield curve, or more specifically, the narrowing gap between yields on 10-year and two-year U.S. Treasuries. Investors demand a higher return for the longer-term commitment, so long as they believe the economy will continue growing. When they don’t, short-term yields can exceed the long end, inverting the yield curve and providing a historically reliable signal of a coming recession.
Most Fed officials, including Powell, have played down the recent flattening of the curve, pointing to technical reasons that have depressed longer-term yields. That hasn’t assured investors.
“The firming of the dollar, combined with a flattening of the yield curve, combined with a bad year for investment-grade credit returns, these are symptoms of a market worried about this cycle being long in the tooth,” said Joseph Lavorgna, chief economist for the Americas at Natixis SA. “If there’s anything hopeful in these minutes, it could be in some further discussion of the yield curve.” — Bloomberg

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