Daily Commentary BY THE CURVE TEAM –

Flexibility The Key For FOMC

10th of January, 2019

After what has been a wild ride for markets and expectations around the outlook, minutes from the Fed’s December meeting added some much needed clarity.

The outlook for the Fed has been hotly debated over the last month. The Fed Chairman’s post meeting speech in December suggested the Fed was set to continue normalising policy through 2019 despite the uptick in market volatility and doubt over the strength of the economic outlook rising.

Chairman Powell then back peddled when reading from a speech more recently following the acute volatility over the holiday period. As a result, expectations for the outlook for monetary policy, and in turn the economy outlook, in the US have swung wildly over the past month.

The minutes from the December meeting were out early this morning and they provide a little more clarity as to what Fed’s outlook was at the time of the December meeting. It’s clear from the minutes that more hikes are coming if the economy remains strong but the Fed remains flexible in the timing of the hikes.

Specifically, the minutes said:

“Many participants expressed the view that, especially in an environment of muted inflation pressures, the committee could afford to be patient about further policy firming.”

And:

“Participants expressed that recent developments, including the volatility in financial markets and the increased concerns about global growth, made the appropriate extent and timing of future policy firming less clear than earlier.”

Many Fed members share similar sentiments in various speeches but it was Chicago Fed President Charles Evans who characterised it best. When questioned on how many rates hikes he still expects he said “three rate increases would be the short answer to your question.”

What is important though is that he quickly added that “I think that the timing is not at all important… whether we get there by the end of 2019 or 2020.”

The key for the Fed is that the real Fed Funds Rate is still close to zero, which means that the overnight cash rate is still around the same level of inflation. So if growth in the US remains strong then real interest rates need to rise.

Also, the dot plots and general consensus of Fed members is that the neutral Fed Funds Rate is closer to 3% which is roughly three hikes away.

So with the minutes clarifying just what the core message from the Fed was supposed to be in December, the focus is now on the outlook. Which ever way the current uncertainties such as the trade deal negotiation, US government shutdown, global outlook and market volatility, move, the key is that the Fed will be flexible in their desire to normalise the overall setting of monetary policy.

David Flanagan

Director - Interest Rate Markets