Washington, D. C., USA: Federal Reserve officials noted that the benchmark federal funds rate could be at or above its “neutral” level “sometime next year.” driven partly by negative risks to the economy from U.S. trade policy which have intensified, minutes of the FOMC June 12-13 policy meeting released at 2pm today show.
A discussion about how high U.S. interest rates should go in this tightening cycle featured prominently in the minutes.
The record show officials debated the risks posed by a mounting dispute between the U.S. and key trading partners, a stronger dollar and the flattening yield curve, concerns that could damp expectations for a faster pace of rate increases.
Chairman Jerome Powell, in his post-meeting press conference, had 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 did not halt the discussion among policy makers.
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.
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, the minutes provided some signal on how Fed officials would react to higher inflation.
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. 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.
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.
“Meeting participants also discussed the term structure of interest rates and what a flattening of the yield curve might signal about economic activity going forward. Participants pointed to a number of factors, other than the gradual rise of the federal funds rate, that could contribute to a reduction in the spread between long-term and short-term Treasury yields, including a reduction in investors’ estimates of the longer-run neutral real interest rate; lower longer-term inflation expectations; or a lower level of term premiums in recent years relative to historical experience reflecting, in part, central bank asset purchases. Some participants noted that such factors might temper the reliability of the slope of the yield curve as an indicator of future economic activity; however, several others expressed doubt about whether such factors were distorting the information content of the yield curve. A number of participants thought it would be important to continue to monitor the slope of the yield curve, given the historical regularity that an inverted yield curve has indicated an increased risk of recession in the United States. Participants also discussed a staff presentation of an indicator of the likelihood of recession based on the spread between the current level of the federal funds rate and the expected federal funds rate several quarters ahead derived from futures market prices. The staff noted that this measure may be less affected by many of the factors that have contributed to the flattening of the yield curve, such as depressed term premiums at longer horizons. Several participants cautioned that yield curve movements should be interpreted within the broader context of financial conditions and the outlook, and would be only one among many considerations in forming an assessment of appropriate policy.” FOMC minutes on the yield curve
If there’s anything hopeful in these minutes, it could be in some further discussion of the yield curve.
The Federal Open Market Committee meeting
The Federal Reserve Act of 1913 charged the Federal Reserve with setting monetary policy to influence the availability and cost of money and credit.
The Federal Open Market Committee (FOMC) meeting is a regular session held by the members of the Federal Open Market Committee, a branch of the Federal Reserve that decides on the monetary policy of the United States.
During these meetings, the FOMC reviews economic and financial conditions and determines the federal funds target rate
A decline in the target rate could stimulate economic growth; however, too much economic activity can cause inflation pressures to build. A rise in the rate limits economic growth and helps control inflation pressures; however, too great an increase can stall economic growth. The FOMC seeks a target rate that will achieve the maximum rate of economic growth.
A change in the federal funds rate can affect other short-term interest rates, longer-term interest rates, foreign exchange rates, stock prices, bond prices, the amount of money and credit in the economy, employment and the prices of goods and services.
So traders and investors around the world usually attempt to predict where monetary policy is headed next in each Fed meeting, and adjust their strategies and portfolios accordingly.
The Federal Funds Target Interest Rate
The federal funds rate is the interest rate that banks charge each other for overnight loans, meaning that it effectively acts as the base interest rate for the US economy. Changes to the federal funds rate will impact short and long-term interest rates, forex rates, and eventually economic factors like unemployment or inflation. This, in turn, will play out across the global economy.
While it doesn’t have a direct say over the rates charged by banks to lend money to each other, the FOMC can indirectly change the fed funds rate using three policy tools that affect money supply. These are open market operations, the discount rate, and reserve requirements.
Open market operations are the buying and selling of government bonds on the open market.
When the FOMC wants to decrease monetary supply it will sell bonds, taking money out of the economy and in turn raising interest rates. When it wants to increase money supply, it will buy bonds, injecting money into the economy and lowering rates.
As well as borrowing this money from each other at the federal funds rate, banks can borrow money directly from the Federal Reserve itself.
The interest rate a bank will have to pay to borrow from the Fed is called the discount rate. A lower discount rate will encourage a lower federal funds rate, and vice versa.
Reserve requirements are the percentage of a bank’s deposits from customers that it has to hold in order to cover withdrawals.
If reserve requirements are raised, then banks can loan less money and will ask for higher interest rates. If they are lowered, then the opposite happens.
Quantitative easing (QE) is an extra measure that the Fed can apply in times of severe financial situation. It is usually only used once the above policy tools have been exhausted.
In function, QE looks fairly similar to open market operations. The FOMC buys securities on the open market, injecting money directly into the system.