The Case in the FOMC Minutes for a Second Rate Hike Being Done Sooner

August 17, 2016

Minutes from the July 26-27 Federal Open Market Committee reveal a range of opinions regarding how soon to undertake a second hike of the federal funds target range. The diversity of views was greater than suggested by the single dissenting vote by Kansas City Fed President George in favor of a hike then. Certainly more than one person attending that meeting with a predisposition to tighten sooner than later, and the reasons for acting reasonably soon are summarized as follows:

Some other participants viewed recent economic developments as indicating that labor market conditions were at or close to those consistent with maximum employment and expected that the recent progress in reaching the Committee’s inflation objective would continue, even with further steps to gradually remove monetary policy accommodation. Given their economic outlook, they judged that another increase in the federal funds rate was or would soon be warranted, with a couple of them advocating an increase at this meeting. A few participants pointed out that various benchmarks for assessing the appropriate stance of monetary policy supported taking another step in removing policy accommodation. A few also emphasized the risk to the economic expansion that would be associated with allowing labor market conditions to tighten to an extent that could lead to an unwanted buildup of inflation pressures and thus eventually require a rapid increase in the federal funds rate. In addition, several expressed concern that an extended period of low interest rates risked intensifying incentives for investors to reach for yield and could lead to the misallocation of capital and mispricing of risk, with possible adverse consequences for financial stability.

The prevailing majority does not appear averse to a rate hike in the second half of 2016 but stressed a number of times that if would be better to have more information confirming renewed faster jobs growth as well as the likelihood of inflation rising to target and staying near that level in a sustained way. It appears that information over the past month and a half have strengthened confidence in these desired developments. The remarks of New York Fed President Dudley yesterday carry particular weight. That position is the third most important one in the Fed hierarchy after the chairman and vice-chairman. The N.Y. Fed president has permanent voting power on the FOMC unlike the other eleven district presidents. Traditionally, the N.Y. Fed president has views very close to the chair of the Board of Governors.

Since the beginning of process of policy normalization at the Federal Reserve, even before quantitative easing was reduced and while the communication task of preparing investors for normalization started, emphasis has been put on the gradual nature of this path. Now considerable evidence exists testifying to the fact that this upswing in Federal Reserve rates will be like no other before it.

  • Eight months (34 weeks) have already elapsed since the first rate increase in mid-December.
  • By comparison, the interval between the first and second rate hikes in the last tightening cycle in 2004 was six weeks. The cycle before that in 1999 put just 8 weeks between the first and second moves. Three cycles ago in 1994, 6-1/2 weeks passed between its first and second rate hikes, and in 1988, Fed officials waited just six weeks.
  • Fed is moving four to five times more slowly than its historical norm. As an adjective to describe the more cautious pace, “gradual” understates the difference of this episode from its four most recent prior tightenings.
  • There has also been a wider passage of time between tightening upswings. Six years elapsed between the cycle that started in 1988 and the next one in 1994. Five years each paced between the 1994 cycle and the one in 1999, and another five years went by before the cycle that began in mid-2004.  But eight years have already gone by since the last tightening cycle began.

In the four previous Fed tightening cycles, the intervals between the second and third interest rate increases was also relatively short.  Such was a mere two weeks in 1988, four weeks in 1994, twelve weeks in 1999 and six weeks in 2004. If the considerably slower pace of action continues, that average space of six weeks between the second and third rate hike suggests that Fed officials will this time separate the two actions by at least a half year.  With such long delays at the short end, market rates have a hard time of leading rather than following the Federal Reserve. Only an unexpectedly steep acceleration of inflation is apt to change this dynamic.

Copyright 2016, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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