The FOMC participants’ views on inflation and the Fed funds rate
FOMC Minutes – Key takeaways (Part 8 of 10)
Inflation and the Fed funds rate
The FOMC meeting minutes were released on Wednesday, April 9. Participants commented on and discussed different sectors and the economic drivers including inflation and the Fed funds rate.
Inflation
Inflation had continued to run below the committee’s 2% longer-run objective over the intermeeting period, but longer-term inflation expectations remained stable. There were a number of views shared among the participants in this regard.
While one suggested that persistently low inflation was a clear reflection of a sizable shortfall of employment from its maximum level, few suggested that factors such as slow growth in prices of medical services had played a notable role in holding down inflation of late, while some recommended that a pickup in nominal wage growth could be a solution.
Most participants expected inflation to return to 2% over the next few years, supported by stable inflation expectations and continued gradual recovery in economic activity.
Fed funds rate
While discussing on the monetary policy going forward, participants focused primarily on possible changes to the committee’s forward guidance for the Fed funds rate. Almost all participants agreed that it was appropriate at this meeting to update the forward guidance. Most participants preferred replacing the numerical thresholds with a qualitative description of the factors that would influence the committee’s decision to begin raising the Fed funds rate.
Most participants also believed that, as part of the process of clarifying the committee’s future policy intentions, it would be appropriate at this time for the Committee to provide additional guidance in its post-meeting statement regarding the likely behavior of the Fed funds rate after its first increase.
Participants observed that a number of factors were likely to have contributed to a persistent decline in the Fed funds rate, including higher precautionary savings by U.S. households following the financial crisis, higher global levels of savings, demographic changes, slower growth in potential output, and continued restraint on the availability of credit.
Although changes in the Fed funds rate directly affects the performance of ETFs tracking Treasury securities like the iShares Barclays 1-3 Year Treasury Bond Fund (SHY), the change cascades along the Treasury yield curve, and eventually affects longer-term Treasury tracking ETFs like the iShares Barclays 20 Year Treasury Bond Fund (TLT) even more, on account of their higher duration. However, with the interest rates remaining low for a longer time and the market expecting a rise, investors sometimes prefer ETFs that are designed to play rising interest rates, such as the SPDR Barclays Capital Investment Grade Floating Rate ETF (FLRN), which tracks floating rate debt of companies like Goldman Sachs (GS) and JPMorgan Chase & Co. (JPM).
Other developments
Several participants pointed to international developments like the larger-than-expected slowdown in economic growth in China and the events in Ukraine that could have an indirect negative implication for the U.S. economic outlook.
In their discussion of recent financial developments, participants saw financial conditions as generally consistent with the committee’s policy intentions. However, a couple of participants pointed to the decline in credit spreads to relatively low levels by historical standard as a risk, where a sharp rise in spreads may have negative repercussions for aggregate demand, while a continuation of the decline in spreads may undermine financial stability over time.
The FOMC meeting participants also laid down the policy actions with respect to the asset purchase program and the Fed funds rate.
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