Federal Reserve officials see increased economic growth and an uptick in inflation as justification to continue to raise interest rates gradually, according to minutes from the central bank’s latest meeting.
Though the policymaking Federal Open Market Committee chose not to hike its target rate at the Jan. 30-31 gathering, members indicated clearly that the path ahead for rates was higher.
Markets greeted the news with a strong bout of volatility. Stocks first spiked higher then receded as bond yields jumped, with the benchmark 10-year Treasury note hitting a fresh four-year high.
Officials concluded that “upside risks” to economic growth had increased thanks to tax cuts, increased consumer spending and confidence and a general plethora of signs that growth was moving along at a sustained pace. Members said they have revised upward the economic projections they made at the previous meeting in December.
“A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate,” the summary stated.
“Almost all participants” saw inflation moving up to the Fed’s 2 percent inflation goal over the “medium term” as growth “remained above trend and the labor market stayed strong.”
The meeting was the last one for Chair Janet Yellen, who had guided the Fed through the first normalization steps following the ultra-accommodative moves taken due to the financial crisis. She was succeed by Jerome Powell, who moved up from a Fed governor position and is expected largely to carry on Yellen’s strategy of gradual rate hikes.
Investors have been watching the inflation picture closely, with worries growing that the Fed may decide to move more quickly than expected if officials deem that policy is too loose for a growing economy.
The remarks came before the release of two government indicators showing even more pressures: a 2.9 increase in average hourly wages for January and an unexpectedly strong 0.5 percent monthly gain in the consumer price index.
Markets already were on edge after the January Fed meeting, during which the committee said it expected that “further gradual adjustments” in monetary policy would be necessary particularly given the progress of inflation towards the 2 percent goal. The two data points, coupled with the somewhat hawkish Fed statement, rocked markets, helping send major stock market averages briefly into a correction.
Wednesday’s market action indicated that stock investors first took the minutes as leaning against aggressive tightening, while bond investors saw it as more hawkish. Ultimately, the fixed income side seemed to carry the day.
“My initial read-through was it leaned a little hawkish considering the came before the last employment report that showed wages picking up and before the latest round of budget proposals. So I was a little surprised when the market decided it wasn’t so hawkish,” said Kathy Jones, senior fixed income strategist at Charles Schwab.
“I’m not really sure why the turnaround. Perhaps people read it a little bit more closely,” Jones added.
Inflation takes focus
Inflation was a popular topic of conversation during the meeting.
Officials deemed that core personal consumption — excluding food and energy — likely will run “notably faster in 2018.” The 2017 level was mired around 1.5 percent for 2017. The Fed’s preferred inflation measure is the personal consumption expenditures index.
“Members expected that economic conditions would evolve in a manner that would warrant further gradual increases in the federal funds rate,” the minutes said. “They judged that a gradual approach to raising the target range would sustain the economic expansion and balance the risks to the outlook for inflation and unemployment.”
The market widely expects the Fed to approve a quarter-point increase at the March meeting that would take the rate up to a target range of 1.5 percent to 1.75 percent. The rate is tied to most consumer debt. In addition to gradually increasing rates the committee also is slowly unwinding its portfolio of bonds, or balance sheet.
Officials said they probably underestimated the effects that the tax cuts passed in December would have on spending and growth. However, they remained unsure of how substantially the cuts would impact wages.
Hundreds of companies have issued one-time bonuses to workers. Committee members said that in discussions with business contacts, it was unclear how long-lasting those cash injections would be.
Data they had seen up to the point of the January meeting showed “few signs of a broad-based pickup in wage growth.”
“With regard to how firms might use part of their tax savings to boost compensation, a few participants suggested that such a boost could be in the form of onetime bonuses or variable pay rather than a permanent increase in wage structures,” the minutes said. “It was noted that the pace of wage gains might not increase appreciably if productivity growth remains low. That said, a number of participants judged that the continued tightening in labor markets was likely to translate into faster wage increases at some point.”
Committee members also discussed conditions in the financial markets.
As of the meeting, the market had continued to hum along after getting off to its fastest start ever in 2018. Stocks did not start tailing off until after the meeting, particularly when the Labor Department reported on Feb. 2 the boost in hourly earnings.
FOMC members considered market valuations at that point to be “elevated” and the product of “broad-based appetite for risk among investors.” Some members cautioned that the Fed should be careful that “imbalances in financial markets may begin to emerge” as growth improves, and that the central bank also should monitor financial stability particularly against the prospects for lowered regulations.