While almost all members of the Federal Reserve voted to raise interest rates in June, the central bank appears to be divided over its longer-term plans as data continue to show that the economy is not vigorously responding to its rate increases, released minutes from the Fed’s closed-door June meeting reveal.
Even among Fed officials who supported increasing the benchmark interest rate in June, several “indicated they were less comfortable” with the Fed’s longer-term plan for raising rates, the meeting notes show.
The minutes also showed central bankers divided over precisely when to begin reducing the Fed's massive balance sheet, a task they have indicated will begin before the end of the year. Some officials argued for beginning to shrink the balance sheet in the next few months, while others advocated waiting to see how the economy progresses.
The Federal Reserve chose to raise its benchmark interest rate by a quarter point, from 1 percent to 1.25 percent, at the conclusion of the June 13-14 meeting, the third such increase in six months. The decision was nearly unanimous, with eight members of the committee voting in favor and only one voting against it.
The interest rate increase was a vote of confidence in the economy. But economists and investors are increasingly questioning whether the economy is strong enough to warrant the Fed’s relatively ambitious pace of rate hikes, as the Fed continues to forecast another rate hike this year and three more rate hikes each in 2018 and 2019.
Fed chair Janet L. Yellen has emphasized that the bank's actions will hinge on the performance of the economy. Thus far, the Fed has not been dissuaded by lower inflation readings that suggest the economy may not be as strong as other economic indicators suggest. The Fed’s favored inflation measure, the core personal consumption expenditure index, grew just 1.4 percent at an annualized rate in May, below the rate that the Fed targets.
The minutes showed the Federal Reserve is focusing intently on this challenge, as it tries to walk an uncertain line between coaxing along a still-mediocre economy and preparing for the next potential economic crisis.
In their June meeting, Fed officials emphasized that the U.S. economy looks strong in many respects. The labor market is strengthening, while business investment and consumer spending appear to be recovering from recent lows. Most Fed officials expected the economy’s growth to rebound significantly in the second quarter.
Yet they also pointed to other measures of the economy that appeared less encouraging — including stubbornly low wage growth and inflation, and slower residential investment, auto sales, and spending by state and local governments.
Fed officials lowered their long-term projections for both inflation and the unemployment rate, while their projected path for interest-rate increases remained mostly unchanged.
Yet in comments to CNBC last week, St. Louis Federal Reserve President James Bullard argued that the Fed should delay further rate hikes until it sees what kind of policies Congress and the Trump administration propose. “The committee has been too hawkish for the data during the last 90 days or so,” he said.
Fed officials say their forecasts have been only modestly affected by the new administration's pledges to cut taxes, reduce regulation and increase spending on infrastructure — measures that, nearly six months into Trump's presidency, have yet to be enacted. Meanwhile, U.S. officials will soon confront the challenge of raising the debt ceiling to continue to fund the government.
As of Wednesday afternoon, markets were projecting a 97 percent chance that the Fed would remain on hold when it meets again in July. Investors saw a nearly 20 percent chance of another rate hike in September, and a 60 percent chance of another rate hike or two by December.
In a news conference following the conclusion of the June meeting, Yellen attributed lower inflation in part to temporary factors, like one-off decreases in the prices for cellphone services and prescription drugs.
She said the Fed is eager to keep increasing interest rates at a gradual pace to avoid a situation in which it would need to raise rates more quickly to offset inflation, which could destabilize the economy. But she said the Fed would remain “attentive” to the fact that inflation continues to underperform their targets.
The lone dissenter to the decision was Minneapolis Fed President Neel Kashkari, who argued in a subsequent op-ed that inflation doesn’t show signs of picking up soon.
“We don’t yet know if that drop in core inflation is transitory,” Kashkari wrote. “In short, the economy is sending mixed signals: a tight labor market and weakening inflation.”
The minutes from the June meeting noted that the Fed's recent rate increases are beginning to be felt among some American borrowers, especially the less wealthy. The minutes noted that credit card borrowing has become more expensive, especially for subprime borrowers, while lending standards for auto loans have tightened.
Yet even with the Fed’s recent rate increases, funding remains easy for most companies and individuals. In fact, the minutes noted, financial conditions have actually eased even as the Fed tightens its interest rates — the opposite of what rate increases are theoretically supposed to do.
The minutes noted that the Treasury yield curve has flattened, meaning that investors are not being rewarded much more for longer-term investments than shorter-term ones — a sign that investors have doubts about the ability of the economy to grow and generate financial returns in the longer run.
Instead, investors appear to be piling into the stock market, which continues to hit record highs, buoyed by solid corporate earnings and expectations of a corporate tax cut.
On July 4, President Trump cheered the stock market increase, tweeting, “Dow hit a new intraday all-time high! I wonder whether or not the Fake News Media will so report?”
But not everyone views the increase in stock prices so positively.
“No one wants to say the ‘b’ word — ‘bubble,’” said Michael Arone, chief investment strategist at State Street Global Advisors. “But I do think that they’re concerned that asset prices have gone a little too far too fast, and have been supported by easy monetary policy conditions. So it might be time to curtail some of that.”
Some Fed members were concerned that investors' strong appetite for risk “might be contributing to elevated asset prices more broadly,” the minutes read. “A few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.”
Financial analysts say the Fed’s decision to begin reducing its holdings of Treasurys and other assets later this year could begin to curtail the boom in equities. The Federal Reserve accumulated more than $4 trillion of securities after the financial crisis in a bid to make lending cheaper and stimulate the economy. Unwinding this large balance sheet should theoretically have the opposite effect on the economy, leading to higher lending costs and slower growth.
The Fed’s decisions to raise the cost of borrowing have been slow to filter into financial markets, said Mark Hamrick, senior economic analyst of Bankrate.com. But at some point, increases to the Fed's benchmark interest rate and reductions to its balance sheet will begin to affect bond markets and raise the price of loans for everyday Americans, he said.
Investors were watching the minutes for further clues as to when the Federal Reserve might begin to unwind its massive balance sheet. At its June meeting, the Federal Reserve described for the first time the mechanism it will use to reduce its balance sheet — a system of caps on the amount of money that is reinvested in the securities, that will gradually increase over the course of the year. In the press conference, Yellen said the system was designed to be as orderly and predictable as possible, and that the Fed hoped it would be as exciting as "watching paint dry.”
The Fed said that it would begin the process in 2017, yet the minutes showed officials still divided over when specifically to begin the task. Several committee members preferred to announce a start to the process within a couple of months, while others argued for delaying the decision until later in the year, to continue to judge the economy’s progress.