FOMC minutes: Fed may go beyond ‘recalibration’; all eyes on Jackson Hole meet

Federal Reserve Chairman Jerome Powell (File image)

Moneycontrol Research

Highlights:

- Fed’s change in stance governed by global slowdown and trade war
- US economy largely robust backed by consumption though there are weak signs on the investment front
- Persistent low inflation and uncertainty on neutral rate are other key challenges
- Post July meet, trade war has intensified and global central banks are keenly positioned for accommodation
- Jackson Hole later this week is an important stopover to reflect upon

Most of the Federal Open Market Committee (FOMC) participants assessed a quarter percentage point policy easing in July meet as part of a recalibration of the monetary policy. The FOMC is the monetary policymaking body of the US Federal Reserve System.

However, post meet, factors such as trade war and the global slowdown, which led to this ‘risk management’ step, have only intensified.  Because of this, there is a case for more policy easing at the Fed and a growing clamour for quantitative easing in a few of the economies.

With this context, we look at FOMC minutes for the rationale for change in stance and the embedded risks and challenges ahead.

Also read: Fed July policy meet: A mid cycle rate adjustment

Reasons for change in Fed’s stance

1. Overall domestic economic outlook remains positive wherein consumption growth which was weak in the early part of the year has scaled back. Having said that, there are some signs of deceleration in economic activity in recent quarters, particularly in business fixed investment and manufacturing. What really weighed on FOMC participants to revise down policy rate path estimates was slowdown in rest of the world, particularly China and Eurozone, and the uncertainty around international trade outlook. The participants suggested that sluggish US business fixed investment spending and manufacturing output has persisted and appears to be a byproduct of the risks and uncertainties associated with weak global economic growth and international trade.
2. Policy easing should help from a “risk management perspective”. There are concerns related to global economic outlook and the number of central banks have only limited policy space to support aggregate demand should the downside risks to global economic growth pan out. Hence, it might be prudent for the Federal Reserve to loosen its monetary policy.
3. This was also in response to low inflation. Powell had earlier observed that persistent low inflation environment is affecting the domestic manufacturing sector and business investment. Most participants acknowledge that long-term inflation expectations either were already below the FOMC’s 2 percent goal or could decline below if inflation persists at this level.

Here, note that two of the FOMC members preferred to make a 50 basis point (bps) rate cut in July rather than a 25 bps cut to address low inflation. They argued that apparent low sensitivity of inflation to levels of resource utilisation meant that a notably stronger real economy might be required to pace the return of inflation to the inflation objective.

Few of the alternative policy options were mentioned such as “makeup strategies”.  Here, inflation readings persistently below the 2 percent objective would mean the US central bank seeks to “make up” inflation shortfalls by easing overall financial conditions. Another possibility might be for the Committee to express the inflation goal as a range centered on 2 percent (Similar to practice by RBI’s inflation targeting framework) and aim to achieve inflation outcomes in the upper end of the range in periods when resource utilisation was high.

Other policy challenges which the FOMC is grappling with include neutral rate and the longer-run normal level of the unemployment rate. Neutral rate is the theoretical policy rate at which the monetary policy is neither accommodative nor restrictive.

Other domestic risks

Looking at other sources of risk, the minutes noted that the US administration and Congress had reached a budget and debt ceiling agreement which removes one source of concern later this year. Furthermore, in assessing vulnerabilities stemming from leverage, it was noted that business leverage was high while that of households was moderate. Build-up in non-financial business sector debt is worrisome as it could amplify adverse macro shocks to the economy. At the same time, financial institutions were viewed as resilient as the risks associated with financial leverage and funding risk were still viewed as low.

However, going forward, global risks that might drive the FOMC to go beyond the “recalibration” attempt are world macro developments and the US-China trade war. Trade war equation has worsened from the time of last policy meet with Donald Trump’s imposition of 10 percent tariff on another $300 billion of imports from China and the latter suspending purchase of US agricultural products.

Trade war has in fact drifted to the realm of non-trade measures to armtwist negotiations. The US designating China as currency manipulator and China looking at ways and means to offload US treasury holdings bring a different spin. Furthermore, “no-deal” Brexit, Hong Kong protests are other risk events on the margins which have gained attention recently.

Also read: Yuan, treasury and gold in trade war crosshairs

Fed’s next policy meet is on September 17-18, but before that, there are central bank meets of ECB (Eurozone, September 12), BOC (Canada, September 4), CBR (Russia, September 6) and RBA (Australia, September 3), which can provide the assessment of global economy and give a clue if competitive accommodative policies are a trend.

The ECB had signalled rate cuts at upcoming meetings and also the options for additional asset purchases. The Central Bank of New Zealand had recently cut policy rate by 50 bps and talked about various options such as quantitative easing and negative interest rates being on the table.

Financial conditions have worsened. So, all signals come up for further “recalibration” though key challenge is when and how to use policy tools when the depth of options are limited compared to what it was before the global financial crises (2007-08). Given this context, Jackson Hole later this week would be an important stopover to reflect upon.

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