The minutes of the March FOMC meeting confirm the view that caution on policy normalisation is appropriate given the greater scope to react to upside rather than downside surprises to the outlook.
Increased downside risks to both the economy and inflation won’t be resolved quickly with the bias likely to be for the Fed to be willing to tolerate the risk of an inflation overshoot to ensure escaping the zero lower bound.
Financial markets have had to endure a lot of inconsistent Fed speak during Q1 but it wasn’t until Yellen’s speech last week that some clarity was really offered.
The minutes of the March FOMC meeting are, on the whole, in tune with what Yellen had to say last week but confirmed that the Fed is divided.
This is clear from the fact that “some participants” were of the view that a hike at the next meeting might be warranted if incoming data was consistent with their expectations. This might explain why the Fed decided to omit the balance of risk assessment from its March statement despite the minutes suggesting these risks were titled to the downside.
Hawkish voting members are in a minority and the centre of gravity from the voting members of the Fed has shifted toward those more worried about the downside risks to the economy and inflation.
The latter is important as confidence that inflation will move toward the 2% goal has been eroded by concern that longer-term inflation expectations might be slipping lower.
Market-based measures of inflation compensation, longer-run inflation expectations from the University of Michigan Survey and even actual inflation will likely be more important data points to watch than the economy/labour market over the coming months.
The minutes show some participants worried that longer-run inflation expectations may move lower if “inflation was to persist for much longer at a rate below the Committee’s objective”.
While the hawks would like to keep alive the thought of a hike in April the minutes show this to be unlikely. This said, as was the case last October, the Fed may use the occasion of the April meeting to signal the potential or not of a June rate hike.
A lot of pieces have to fall into place for a June hike (payroll, CPI, Retail Sales etc.) with the additional factor of European related risks coming back on the radar (Brexit/Grexit). A Fed that is not trigger happy and willing to tolerate the risk of an inflation overshoot is supportive for risk assets.
