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

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

The minutes of the March 2018 Federal Open Market Committee (FOMC) meeting affirmed our outlook that the Fed will likely continue to gradually and methodically increase interest rates and that the bar is relatively high for policymakers to change the current plan for two or three more hikes in 2018. Beyond this year, the policy picture is less clear but nearly all FOMC participants now expect a mild overshoot of the inflation target by 2020 – although this doesn’t necessarily mean they are comfortable with a more pronounced period of above-target inflation.

Policy rate outlook

The bar appears high to change the Fed’s current plan to hike interest rates two to three more times in 2018. At the March meeting, most if not all Fed officials upgraded their near-term outlook for U.S. economic activity, citing more expansionary fiscal policy, solid global growth and still easy financial conditions. And although a number of participants thought 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 in 2018 and all participants agreed that it would “remain appropriate” to maintain the gradual approach that has so far characterized the current hiking cycle. While the prospects for retaliatory tariffs and a further escalation in trade tensions were mentioned as a downside risk, participants appeared to shrug off the increase in equity market volatility since 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 to raise the fed funds rate above its longer-run normal rate, there seems to be uncertainty around what level of the fed funds rate is consistent with neutral policy, and participants expressed a “range of views on the amount of policy tightening that would likely be required over the medium term.” The widely followed Laubach 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 will have to continue to assess changes in economic conditions resulting from a gradual tightening of monetary policy to evaluate the neutral policy rate. (For PIMCO’s latest views on The New Neutral for monetary policy, please read our Cyclical Outlook, “The Beginning of the End?” )

Forecasting above-target inflation by 2020

For the first time since the 2008 financial crisis, the March Summary of Economic Projections (SEP) reported that the median FOMC participant forecasts core inflation to mildly overshoot (to 2.1%) the Fed’s longer-term target of 2.0% year-over-year (as measured by Personal Consumption Expenditures or PCE) by 2020. To be sure, the expected overshoot was mild, but notable since it coincided with material upward revisions to the median 2018 and 2019 real GDP growth forecasts and downward revisions to the unemployment rate path.

The combination of these revisions suggests that many FOMC participants believe that the appropriate monetary policy is one that does not pre-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 FOMC participants’ tolerance for above-target inflation. While a number of participants suggested that a prolonged period of above-potential growth could help anchor inflation expectations, they also worried that an “overheated economy could result in significant inflation pressures or lead to financial instability.” Fed policymakers won’t lose sight of their mandate.

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

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

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