FOMC Minutes Signal Only Slow Balance Sheet Wind Down With Slow Rate Hike Plans

The U.S. Federal Reserve has released the minutes of the September 2017 FOMC meeting, and the investing community and economic watchers should take the notion that the current members are not looking to shake up the economic recovery all that much. Then again, the composition of the FOMC and the even who will become Chairman next year could bring more changes than the views expressed here.

It turns out that the September 19-20 FOMC meeting was relying on stronger labor market in July and August and moderate growth in real gross domestic product — at least before the landfall of Hurricanes Harvey and Irma. The FOMC admitted that there were few real numbers showing the impact of the two storms were available at the time of the FOMC meeting. Their initial view was that the negative effects would restrain national economic activity only in the near term.

The FOMC noted that consumer price inflation (CPI) has continued to run below 2% in July and was lower than at the start of the year, with longer-run inflation expectations seen as little changed on balance. Several pieces of information suggested that real PCE was likely increasing at a slower rate in the third quarter than in the second.

The FOMC also guided down the pace of rate hikes with this statement:

FOMC communications over the intermeeting period reportedly were interpreted as indicating a somewhat slower pace of increases in the target range for the federal funds rate than previously expected.

Additional commentary was made about the staff’s economic outlook. The FOMC addressed Real GDP and inflation as follows:

Real GDP was expected to rise at a solid pace, on net, in the second half of the year, and by a little more than previously projected, reflecting data on spending that were stronger than expected on balance. The short-term disruptions to spending and production associated with Hurricanes Harvey and Irma were expected to reduce real GDP growth in the third quarter and to boost it in the fourth quarter as production returned to its pre-hurricane path and as a portion of the lost spending was made up. The hurricanes were also expected to depress payroll employment in September, with a reversal over the next few months. Beyond 2017, the forecast for real GDP growth was little revised. In particular, the staff continued to project that real GDP would expand at a modestly faster pace than potential output through 2019. The unemployment rate was projected to decline gradually over the next couple of years and to continue running below the staff’s estimate of its longer-run natural rate over this period. Because of continued subdued inflation readings and, given real GDP growth, a larger-than-expected decline in the unemployment rate over much of the past year, the staff revised down slightly its estimate of the longer-run natural rate of unemployment in this projection.

The staff’s forecast for consumer price inflation, as measured by the change in the PCE price index, was revised up somewhat for 2017 in response to hurricane-related effects on gasoline prices. The near-term forecast for core PCE price inflation was essentially unrevised. Total PCE price inflation this year was expected to run at the same pace as last year, with a slower increase in core PCE prices offset by a slightly larger increase in energy prices and an upturn in the prices for food and non-energy imports. Beyond 2017, the inflation forecast was little revised from the previous projection. The staff continued to project that inflation would edge higher in the next couple of years and that it would reach the Committee’s longer-run objective in 2019.

And finally, the expectations for how the Fed will run down its massive $4.5 trillion balance sheet. On this notion, the minutes said:

Many underscored that the reduction in securities holdings would be gradual and that financial market participants appeared to have a clear understanding of the Committee’s planned approach for a gradual normalization of the size of the Federal Reserve’s balance sheet. Consequently, participants generally expected that any reaction in financial markets to the start of balance sheet normalization would likely be limited.