From Elliot Clark at Westpac:
The minutes of the October FOMC policy meeting signal that the Committee is, by and large, in agreement that a first rate hike at the December meeting is a strong possibility. This probability has firmed further since, on the back of recent jobs and inflation data.
The labour market remains critical for the FOMC’s policy assessment. In October, “Almost all members agreed that, even though the pace of job gains had slowed and the unemployment rate had held steady over the intermeeting period, labor market indicators, on balance, showed that underutilization of labor resources had diminished since early in the year”.
Further, from the tone of the discussion, it was clear that the majority believed the economy was at or near full employment. For those who disagreed at the time of the meeting (seeing greater slack and a risk that momentum had been lost), the subsequent October employment report will have provided comfort, with the pace of hiring accelerating again; positive back revisions; and a further decline in the unemployment rate.
Views on real activity in the minutes were, broadly speaking, more positive. On consumption, “Notwithstanding the disappointing retail sales data in September, participants were encouraged by the solid pace of consumption growth in the third quarter and generally expected consumer spending to rise moderately going forward”. Job growth; oil-induced real wage gains; and robust confidence all pointed to a favourable outlook for the Committee. Arguably this extends to housing, which has “improved further”.
TGiven the divergence between employment and investment growth and the ongoing weakness in durable goods orders, it was interesting that the FOMC saw business investment “increasing at a solid rate”. Weakness in energy sector investment was noted, but specific concern on this front for the outlook was absent; this was also the case for the US dollar’s impact. Vis a vis the potential for inventory adjustments, the negative effect on Q3 growth was noted, but “further outsized declines” were regarded as unlikely.
On external demand, while there was an expectation that the strong US dollar and weak global economy would continue to weigh on growth in the second half, more broadly, external risks to the outlook reportedly have diminished – with financial market volatility abating and September’s US equity declines reversing.
Inflation remains the one key area of concern for the Committee, with headline inflation remaining near zero and inflation expectations stable well below their long-term average. “Nonetheless, participants generally continued to anticipate that, with appropriate monetary policy, inflation would move toward the Committee’s objective over the medium term, reflecting the anticipated tightening of product and labor markets, the waning of downward pressures from energy and import prices, and stable inflation expectations”.
This expectation has subsequently received additional support from the October CPI report, wherein annual headline inflation rose to 0.2% as core inflation remained broadly in line with the FOMC’s 2.0% medium-term target.
The conclusion from this broad discussion is that “Most participants anticipated that, based on their assessment of the current economic situation and their outlook for economic activity, the labor market, and inflation… conditions could well be met by the time of the next meeting”. This would provide scope for the first US rate hike in close to a decade.
While this will be a significant event, as we and the FOMC have continued to highlight in recent years, for the economy and financial markets, the first move is of less significance than the pace of normalisation thereafter, which will prove protracted.
As per their discussion of equilibrium real interest rates in these minutes, the eventual terminal rate for this cycle will likely be much lower than has been the case historically. And the FOMC is clearly in no rush to get there.
Specifically, “participants generally agreed that it would probably be appropriate to remove policy accommodation gradually”. It was also noted that “beginning the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow”, keeping term rate expectations contained and giving the economy more time to adjust to the new policy paradigm. All of this argues for a first rate hike in December, but a cautious FOMC through 2016.
The MB base case is the FOMC will hike in December then get two more away next year before blowing up the global business cycle. Could be more, could be less, but that outcome is solid.
