The minutes of the January 2015 Federal Reserve board meeting were released this past week. There were plenty of market action review items to open the minutes. Most of which were around the robustness of market intervention policies when normalization of rates commences. In the section titled, “Staff Review of the Financial Situation”, there is this comment:
…reflecting in part the deterioration in market sentiment, the expected path for the federal funds rate implied by market quotes shifted down. Results from the Desk’s January Survey of Primary Dealers indicated that dealers continued to put the highest probability on scenarios in which the FOMC chooses to commence policy firming around the middle of the year, although the average probability assigned to a commencement after June increased somewhat.
As I have noted in the past, I am strongly in favor of rate normalization beginning in March. But as I have been instructed, you work with the market you have not the market you want. In this case, market sentiment is moving after the middle of the year for a rate change. No one at the Fed has signaled a change in probable policy from the middle of the year. This will bear watching.
Later on, we get to the section titled, “Participants’ Views on Current Conditions and the Economic Outlook” and find this part of the first paragraph:
Although growth likely slowed from the rapid rate recorded for the third quarter of 2014, a variety of indicators suggested that real GDP continued to grow faster than potential GDP late in the year and during January.
This seems to one of the first signs of when the economy is performing better than expected and rate normalization may commence.
Further down, we find an unusual comment about inflation:
It was pointed out that the recent intensification of downward pressure on inflation reflected price movements that were concentrated in a narrow range of items in households’ consumption basket, a pattern borne out by trimmed mean measures of inflation.
The trimmed mean inflation measures were pioneered by the Dallas branch of the Federal Reserve. They are generally considered better indicators of overall inflation than core PCE since volatility is retained and only those two measures at the extreme ends are kicked out. While core PCE removes Food and Energy subcomponents, the trimmed mean until recently has removed Energy and Communications subcomponents.
After this are two lengthy paragraphs devoted to the discussion around the timing of rate normalization including the risks of commencing later than the market perceives is necessary and earlier than the market wants. It is fairly clear there was a significant amount of time devoted to this subject. It was also noted that one participant wanted to ease further until the targeted inflation rate of two percent was reached. In terms of passing along a set of indicators for when rate normalization would begin, most of the participants’ noted that would be difficult. Interesting that it wasn’t difficult in the past, yet we went through those measures and rates have not changed. Maybe that is why it is difficult now. Then these comments on inflation measures are mentioned:
Many participants indicated that such economic conditions would help bolster their confidence in the likelihood of inflation moving toward the Committee’s 2 percent objective after the transitory effects of lower energy prices and other factors dissipate. Some participants noted that their confidence in inflation returning to 2 percent would also be bolstered by stable or rising levels of core PCE inflation, or of alternative series, such as trimmed mean or median measures of inflation. A number of participants emphasized that they would need to see either an increase in market-based measures of inflation compensation or evidence that continued low readings on these measures did not constitute grounds for concern. Several participants indicated that signs of improvements in labor compensation would be an important signal, while a few others deemphasized the value of labor compensation data for judging incipient inflation pressures in light of the loose short-run empirical connection between wage and price inflation.
From my perspective, the Fed’s mandate is to control inflation, not wages. In addition, that last sentence should be noted since there are many studies showing the weak link between wage growth and inflation. Targeting wage growth would send the wrong signal regarding what is important in the economy. With wages little changed in the past ten years and debt as a percent of income continuing to rise, it seems that wage growth would have a tendency to go more towards debt reduction rather than consumer purchases. That reduction in debt would be a deflationary indicator. It is thus more important to target price inflation instead.
An interesting meeting from my perspective. There seems to be more interest in allowing the market to dictate when rates should normalize and that seems to be moving later in the year. While no explanation was given for what is moving the market, I have mentioned the impact of divergence in global policy in the past. There are some economists who will argue for a later move to rate normalization because of the relative tightening the Fed is doing (no action while others are easing is the equivalent of becoming tighter on a relative basis). There also seems to be some voices within the committee that are watching the wrong indicators. I still hold the belief the Fed should be a national bank rather than the world bank and they should do what is best for the domestic economy. In fact, that would be just what the Bank of Japan and the European Central Bank are doing.