Anubhav Sahu Moneycontrol Research
Highlights:
- Fed rate is at or close to the lower end of the neutral interest rate
- It sees relatively limited amount of additional tightening
- Inflation readings, post oil price decline, provides room for a pause
- Progress in the US-China trade assumes importance for business sentiment
- China’s annual plenum and Brexit developments are key events to watch out for
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If there was still some doubts on the US Federal Reserve’s stance, the minutes of its December meeting puts that to rest. The US central bank is now on a wait and watch mode. While the December dot plot suggested moderation in rate hikes and a longer run level for the funds rate (2.8 percent), the Fed’s official statement implies that rate hikes would happen only if warranted.
The minutes stated: "The Committee judged that a relatively limited amount of additional tightening would be appropriate." At the same time, emphasising that the Federal Open Markets Committee (FOMC) would continue to monitor global economic and financial developments and assess implications for the economic outlook.
To make it more categorical, FOMC stated that with the December rate hike the federal funds rate is at or close to the lower end of its estimated range of its longer-run neutral interest rate. This means the policy rate is nearing levels where it neither stimulates nor restrains economic growth by changing its interest rate policy.
At the same time, members mentioned that recent developments (financial market tightness and global growth slowdown) have led to a situation where the appropriate extent and timing of future policy firming is less clear than earlier.
Now what qualifies this stance as a wait and watch mode?
Change in optics: The post meeting phrase, 'The committee expects further gradual increases' was modified to 'the committee judges some further gradual increases'. This implies growing uncertainty in the Fed funds rate path and emphasis, policy action is data dependent and there is limited scope for increase in the policy rate.
While current assessment for the economy (mid-December 2018) remains strong, financial conditions have tightened and global growth has moderated. Next step would also depend upon readings on financial and international developments. The Fed notes that there is visible contrast in the strength of incoming data on economic activity and concerns about downside risks is evident in financial markets and in reports from business contacts regarding global economic outlook.
Overall household spending was strong though several participants noted continued weakness in residential investment. This weakness was attributed to a variety of factors, including increased mortgage rates and rising home prices. Additionally, reports from District contacts in the automobile sector were mixed.
Contrast was also evident in business activity and sentiment. While recent data pointed to a rebound in investment spending, business sentiment seems weighed by trade policy, waning fiscal stimulus and moderation in global growth.
Fed’s survey in the agricultural sector suggest that conditions remained depressed on account of trade policy actions, uncertainty in exports and continued low commodity prices. The minutes mention that banks continued to report a gradual increase in agricultural loan delinquencies in recent months.
Core inflation readings have edged lower in recent months. Many FOMC participants remarked that longer-term TIPS (Treasury Inflation-Indexed Security)-based inflation compensation had declined notably since November on account of a decline in oil prices and deterioration in investor risk sentiment.
Trajectory for 10 year TIPS (Treasury Inflation-Indexed Security)
Key takeaway: Longer pause in rate hike possible Fed minutes suggest a longer pause than was reflected after the December Fed meet. There are substantial divergence in views with respect to Fed policy path and concerns over global growth and trade policy. While the tightness in the labour market suggest gradual improvement in wages, there is a downward bias in inflationary expectations, which should provide time for the Fed to calibrate.
Global developments and financial conditions assumes centre stage and given this context, outcome of the first round of US-China trade talks is eagerly awaited. At the same time, China’s communist party plenum (January 19-22) assumes importance when traditionally major reforms are announced. Progress in Brexit also assumes importance as the deadline (March 29) gets closer.
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