FOMC Minutes Appeared Hawkish As Members Discussed Exit Principles In Details

The FOMC minutes for the July meeting unveiled that policymakers had detailed discussion of the exit strategy. The Fed has also planned to officially update their exit principles later this year. We expect to see the update in September. On the economic outlook, the member acknowledged the improvement in the job market. Yet, they remained divided over whether the unemployment rate served as an accurate indicator of the labor market conditions. The staff revised potential growth lower and inflation higher while expecting inflation to stay below the Fed’s mandate for several years. The staff also lowered the unemployment rate forecast in response to the faster decline in the unemployment rate.

Exit Strategies

On the exit principles, the minutes suggested that the members were generally supportive of approach outlined by the staff. Most of them agreed that it would be ‘appropriate to retain the federal funds rate as the key policy rate, and they supported continuing to target a range of 25 basis points for this rate at the time of liftoff and for some time thereafter’. One member, however, suggested using ‘the range for the federal funds rate as a communication tool rather than as a hard target’. There’s also another member suggesting to focus on ‘the rate of interest on excess reserves (IOER) and the ON RRP rate’ in addition to the Fed funds rate.

The members agreed that the IOER rate would be the ‘primary tool’ for moving the Fed funds rate to the target range and ‘influence other money market rates’. Most of them also believed a ‘temporary use of a limited-scale ON RRP facility would help set a firmer floor under money market interest rates during normalization’. They also expected that the IOER rate would be set ‘at the top of the target range’ for the Fed funds rate and the ON RRP rate would be set ‘at the bottom’ of the target range, at least in the beginning. There were some members who suggested that the ON RRP rate could be set ‘below the bottom’ of the target range, believing that it would allow the normalization process to begin with ‘minimal or no reliance on an ON RRP facility and increase its role only if necessary’. Such strategy was disagreed by many others amidst the concern that this would lead to ‘insufficient control of money market rates at liftoff’ and cause ‘confusion about the likely path of monetary policy or raise questions about the Committee’s ability to implement policy effectively’.

We expect the Fed would publish an official update on the exit principles in the September meeting during which the central bank would also give a forecast update and a post-meeting press conference. The Fed would likely prefer to give more information about the exit strategy to the public before the tapering ends in October.

Labor Market

While we would hear more from Chair Yellen and other Fed members regarding their views on the labor market conditions as the Jackson Hole conference begins today, the minutes revealed that the members remained divided over the unemployment rate could send accurate signal about labor market conditions. The minutes noted that ‘a few’ judged that that the unemployment rate had been reliable in summarizing the overall state of the labor market and the Fed needs to prepare for a faster transition to rate hikes after QE tapering ends. Yet, ‘many participants’ continued to see ‘a larger gap between current labor market conditions and those consistent with their assessments of normal levels of labor utilization than indicated by the difference between the unemployment rate and estimates of its longer-run normal level’. They noted that the long term unemployment remained elevated while participation rate remained low. In short, while most of the members agreed that the job market has picked up, they continued to see that the job market is ‘far from normalized’.

Staff Economic Outlook

Concerning the staff’s economic projection, the minutes showed downward revisions in potential growth and upward revision in inflation outlook. Meanwhile, the unemployment rate forecast was also lowered as a result of the faster decline in unemployment rate forecast. It has been the Fed staff’s practice in recent meetings to reconcile the faster decline in the unemployment rate by lowering its unemployment rate forecast and reducing estimate of potential growth more than its outlook for growth in upcoming quarters. Such practice has suggested to us that less growth is needed to push the unemployment rate lower over time.

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