Fed minutes show confidence in 2020 interest rate path
Federal Reserve policymakers appeared more confident in their stance on interest rates at their last policy meeting, noting that risks to the global economy were easing and considering the possibility that the US labour market could get even better.
That optimism underscored the central bank’s intention to leave short-term interest rates at 1.5 to 1.75 per cent through the end of 2020.
According to the minutes of the Fed’s December meeting, released on Friday, “Participants remarked that there were some indications that further strengthening in overall labour market conditions was possible without creating undesirable pressure on resources.”
In other words, unemployment can remain low and wages can continue to rise without moving inflation higher. Unemployment in the US already sits at 3.5 per cent, a 50-year low. Wage growth, particularly for production-level workers, remains close to post-crisis highs, though still lower than in previous economic expansions.
Policymakers were particularly confident the labour force participation rate could continue to rise, according to the minutes. Participation, a measure of worker confidence that there are good jobs to be found, has by some measures only recently recovered from its post-crisis lows.
In its statement and economic projections after its December meeting, the Fed capped a year-long shift in policy — it spent 2019 lowering its main policy rate by a cumulative 75 basis points — suggesting it was prepared to hold rates low until the US economy generates more inflation.
The minutes gave little reason to believe policymakers were hesitant about their decision.
“The Fed is really balanced in terms of their assessment of the strength of the economy and their approach,” Michael Arone, chief investment strategist at State Street Global Advisors, said. “They are quite comfortable with the current approach to monetary policy and they are quite unified.”
Looking abroad, the source of much of the central bank’s concern during 2019, participants at the Fed meeting noted that “tentative signs that trade tensions with China were easing, and the probability of a no-deal Brexit was judged to have lessened further.”
“In addition, there were indications that the prospects for global economic growth may be stabilising. A number of participants observed that the domestic economy was showing resilience in the face of headwinds from global developments.”
Treasuries were little changed following the release of the minutes. During the day, the yield on the 10-year Treasury fell 9 basis points to 1.79 per cent, while the yield on the more policy-sensitive two-year note lost 4bp to 1.53 per cent.
US equities failed to trim earlier losses, and the S&P 500 closed 0.7 per cent lower.
Traders are still pricing in at least one quarter-point reduction in the Fed’s benchmark policy rate by December.
John Herrmann, director of interest rate strategy at MUFG Securities, said the US economy was still not ready to withstand tighter monetary policy. “We are hoping they don’t throw a monkey wrench into the engine . . . by suddenly shifting the tone and the language to rate hikes,” he said. “That would be a big mistake.”
During the December meeting, Fed officials also discussed additional measures to address strains that have cropped up in short-term funding markets since September, when the cost of borrowing cash overnight spiked to 10 per cent.
Over the past three months, the New York Fed has injected billions of dollars into the repo market, where investors exchange high-quality collateral like Treasuries for cash. The Fed has also been buying Treasury bills, which have a maturity of one-year or less, at a pace of $60bn per month, in order to boost banks’ reserves.
While the recent operations have kept a lid on short-term borrowing costs, the minutes showed the central bank is open to other strategies to address the problem. Fed officials discussed the possibility of buying other short-term securities beyond Treasury bills if needed, as well as the prospect for reducing the daily operations in the repo market sometime after the April tax season.
“They provided the needed liquidity to calm the repo market during a time for stress, but it was somewhat of a blunt-force instrument,” said Mr Arone. “I think they are looking for better ways to anticipate those risks and better ways to more quietly influence the market.”