The minutes of the decisive 16 December Federal Open Market Committee (FOMC) meeting provide some nuance and color to complement the committee’s statement and Fed Chair Janet Yellen’s press conference that immediately followed the meeting. But these minutes were not expected to make news, and they didn’t. Rather, they reinforce the key themes the Fed laid out in December to justify its first hike since 2006 and, more importantly, to explain its projection that the liftoff trajectory for rates in this cycle will be “gradual,” a word that was used 15 times in these minutes! The minutes remind us, as did Chair Yellen in her press conference, that liftoff is projected to be gradual for several reasons:
- First, the Fed sees downside risk to its inflation projections and wants to monitor closely “actual inflation” as well as measures of “inflation compensation.”
- Second, the Fed spent time at this meeting (as it did in October) discussing its belief that there is a new “neutral” for the appropriate policy rate (which is well below pre-crisis levels) and that this neutral policy rate is expected to rise only “slowly over the next few years.”
- Third, the Fed spent more time than I expected at a meeting where it decided to hike for the first time in nine years discussing the “asymmetric” risks it faces by lifting off with inflation below target and global growth slowing.
As for the number of hikes we can expect this year, Vice Chairman Stanley Fischer said today that the four hikes indicated by the blue dots in the Fed’s December Summary of Economic Projections (SEP) are in “the ballpark.” Our baseline view at PIMCO remains that we will see fewer than four hikes in 2016, but likely more than the market is currently pricing in. Fed policy going forward, the minutes remind us, will be “informed by incoming data.” There will be plenty of data between now and March (certainly there is no indication that the Fed will make any changes to policy at its January meeting), and the inflation data as well as the GDP data will be followed closely by the Fed – and the markets.
Of course, investors are scrutinizing other developments along with Fed policy, and their concerns are evident in this week’s choppy markets. China’s move to weaken its currency (amid a market drop linked to soft manufacturing data, one more sign of a slowing economy), along with disappointing data in the U.S. and geopolitical tensions in North Korea and the Middle East, plus uncertainty over oil prices, all underpin the market weakness this week. It’s not a pleasant way to start the year, and market volatility – with positive as well as negative surprises – has probably become a fact of life. Overall, however, we expect the economy to plod along in 2016 much as it did in 2015. And with all eyes on the Fed.