Janet Yellen: ‘I will not say that the committee clearly understands what the causes of [this year’s inflation undershoot] are’ © EPA
Worries about the risk of stubbornly low inflation hung over the Federal Reserve’s most recent policy meeting, even as the central bank held its course for a further rate rise as soon as the end of the year.
Many of the US central bank’s policymakers declared at its latest rate-setting meeting that a further increase is likely to be needed “later this year” as long as the economy stays on track.
But minutes of the Fed’s gathering on September 19-20 revealed a body of policymakers who are troubled by this year’s doggedly weak inflation readings and divided over how best to respond.
Many expressed worries that poor price growth could reflect entrenched factors following a half-decade of sub-target readings on the Fed’s favoured measure of core inflation. Several insisted they wanted to see economic data that “increased their confidence” that inflation would move towards the Fed’s 2 per cent objective before they acted again.
The Federal Reserve put its stimulus programme into reverse at the September meeting as it announced the gradual reduction of a balance sheet swelled to $4.5tn by quantitative easing — a well-telegraphed move that meeting participants said should not jolt markets.
Having navigated that step, the question now facing Fed chair Janet Yellen and her committee is whether to push through a further increase in short-term rates by the end of the year, with expectations centring on December.
The dollar remained under pressure after the meeting minutes were released, with the index tracking it against a basket of peers down 0.3 per cent. But the minutes did little to shift expectations of a near-80 per cent probability that the Fed would raise rates at the December meeting — with both 10-year Treasury yields and the more rate-sensitive two-year Treasury yields left unmoved.
While traders are betting heavily on the rise at the December 12-13 meeting, the Fed has been unable to shake off a procession of disappointing inflation readings and a number of policymakers now expect it to take longer than previously expected for inflation to return to target.
The jobs market has continued to strengthen, with a hurricane-related slowdown in hiring failing to stop the unemployment rate from dropping to 4.2 per cent in September.
Yet at the same time core inflation measured by the Fed’s favoured index has failed to hit the 2 per cent target since 2012 and slowed to just 1.3 per cent year-on-year in August. In a September speech, Ms Yellen said “many uncertainties” surrounded the Fed’s assessment of inflation, adding that “downward pressures on inflation could prove to be unexpectedly persistent.”
The minutes revealed a lengthy debate among Fed officials over what might be going on with the inflation data — with no decisive conclusions emerging. Many participants thought that “another increase in the target range later this year was likely to be warranted if the medium-term outlook remained broadly unchanged.”
However others participating in the discussion said they were worried the soggy numbers were not a fleeting problem but a reflection of “more persistent” developments. Some wanted firmer evidence that inflation is on the right track before acting again, and a few went as far as to argue that no further rate rises were now warranted in the near-term and that the trajectory of the federal funds rate might need to be “quite shallow”.
Some of the speakers at the meeting fretted that long-term trends such as technological innovation and its effects on corporate pricing could be having an “intensifying” impact on inflation. Several also warned that the trend rate of inflation was deteriorating below 2 per cent, something that could pull inflation expectations lower.
“Many participants expressed concern that the low inflation readings this year might reflect not only transitory factors, but also the influence of developments that could prove more persistent, and it was noted that some patience in removing policy accommodation while assessing trends in inflation was warranted,” the minutes said.
At the other end of the debate, some of the officials were more worried that inflation could end up jumping given the jobs market is already at full employment and may be poised to “tighten further”. These individuals’ worries were further heightened by the easing of financial conditions since the Fed started its rate-raising cycle in late 2015.
Traders have been betting heavily on a further Fed rate increase in December. But the outlook for US monetary policy is doubly uncertain given the major personnel upheaval that is currently in the works.
President Donald Trump is debating whom to appoint as Fed chair when Janet Yellen’s term expires in February. In addition, vice-chair Stanley Fischer has announced his retirement, and further board vacancies need to be filled.