With Federal Reserve Chair Janet Yellen on Capitol Hill for two days of testimony last week, plus Vice Chairman Stanley Fischer’s interview on Bloomberg TV, plus the upside surprise on U.S. CPI inflation data released on 15 February, the minutes released today from the Federal Open Market Committee (FOMC) meeting of 31 January – 1 February run the risk of being a bit stale and subject to overinterpretation. The important takeaway from the minutes is that “many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations … ” (italics mine).
So, does “fairly soon” equal March? While a March rate hike is certainly possible, the FOMC “members,” who are voters – as compared with “participants,” who do not vote – did not appear confident that a March hike would be appropriate. For example, “Many members continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly. These members expressed the view that inflation was likely to rise toward 2 percent gradually, and that policymakers would likely have ample time to respond if signs of rising inflationary pressures did begin to emerge.”
Very relevant to the March decision is that the Fed has not yet begun to refine and reach agreement on how to manage the normalization of its balance sheet. If the Fed were to hike in March without preparing the markets – and as of this writing, a few hours after the minutes were released, the probability of March is just 34%, unchanged from two days ago (see chart below) – then market participants would look for clarity on the path for the balance sheet, and would likely price in an additional hike for 2017. One of the voting members did note that “if incoming data on the economy and inflation were consistent with expectations, taking the next step in reducing policy accommodation relatively soon would give the Committee greater flexibility in calibrating policy to evolving economic conditions.”
So yes, there is a case for the Fed to remove accommodation at the March meeting. These minutes reveal a committee that wants the option to hike, but without the conviction that it will do so.
Richard Clarida is PIMCO’s global strategic advisor and a frequent contributor to the PIMCO Blog.