Fed Minutes: Policymakers Shrug at Market Volatility, Stay Focused on Gradual Path

Fed Minutes: Policymakers Shrug at Market Volatility, Stay Focused on Gradual Path

Theminutesof the March 2018 Federal Open Market Committee (FOMC) meeting affirmed ouroutlook that the Fed will likely continue to gradually and methodicallyincrease interest rates and that the bar is relatively high forpolicymakers to change the current plan for two or three more hikes in2018. Beyond this year, the policy picture is less clear but nearly allFOMC participants now expect a mild overshoot of the inflation target by2020 – although this doesn’t necessarily mean they are comfortable with amore pronounced period of above-target inflation.

Policy rate outlook

The bar appears high to change the Fed’s current plan to hike interestrates two to three more times in 2018. At the March meeting, most if notall Fed officials upgraded their near-term outlook for U.S. economicactivity, citing more expansionary fiscal policy, solid global growth andstill easy financial conditions. And although a number of participantsthought a “slightly steeper” path of the fed funds rate was now warranted,the committee was split as whether that meant two or three more hikes in2018 and all participants agreed that it would “remain appropriate” tomaintain the gradual approach that has so far characterized the currenthiking cycle. While the prospects for retaliatory tariffs and a furtherescalation in trade tensions were mentioned as a downside risk,participants appeared to shrug off the increase in equity market volatilitysince the beginning of the year.

Looking further out to 2019 and 2020, the policy picture is more uncertain.Although several participants believed it would likely be appropriate toraise the fed funds rate above its longer-run normal rate, there seems tobe uncertainty around what level of the fed funds rate is consistent withneutral policy, and participants expressed a “range of views on the amountof policy tightening that would likely be required over the medium term.”The widely followedLaubach and Williams natural interest rate model currently estimates the real neutral rate is around 0.0%, implying a 2%neutral nominal fed funds rate is consistent with neutral policy. However,uncertainty surrounding the model is great, and therefore the FOMC willhave to continue to assess changes in economic conditions resulting from agradual tightening of monetary policy to evaluate the neutral policy rate.(For PIMCO’s latest views on The New Neutral for monetary policy, pleaseread ourCyclical Outlook, “The Beginning of the End?”)

Forecasting above-target inflation by 2020

For the first time since the 2008 financial crisis, theMarch Summary of Economic Projections (SEP)reported that the median FOMC participant forecasts core inflation tomildly overshoot (to 2.1%) the Fed’s longer-term target of 2.0%year-over-year (as measured by Personal Consumption Expenditures or PCE) by2020. To be sure, the expected overshoot was mild, but notable since itcoincided with material upward revisions to the median 2018 and 2019 realGDP growth forecasts and downward revisions to the unemployment rate path.

The combination of these revisions suggests that many FOMC participantsbelieve that the appropriate monetary policy is one that does notpre-emptively tighten to offset the strengthening tailwinds to growth,including the more expansionary fiscal policies.

Still, on balance, the minutes leave us cautious about extrapolating FOMCparticipants’ tolerance for above-target inflation. While a number ofparticipants suggested that a prolonged period of above-potential growthcould help anchor inflation expectations, they also worried that an“overheated economy could result in significant inflation pressures or leadto financial instability.” Fed policymakers won’t lose sight of theirmandate.

Read more blogs on rates.

Read PIMCO’s latest Cyclical Outlook for insights into global economic growth and monetary policy in 2018.


Tiffany Wilding is a PIMCO economist focusing on the U.S. and is a regular contributorto the PIMCO Blog.


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