December 2015 FOMC minutes: time to validate reasonable confidence

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There was very little new information about the policy outlook in the December FOMC meeting minutes. On the surface, it might appear that the Committee’s conviction in the inflation outlook is less than previously thought. After all, there were a couple of references in the minutes to the considerable uncertainty surrounding inflation forecasts, and downside risks to the inflation outlook as relates to commodity prices, the dollar, and global disinflationary forces. But the overall level of uncertainty regarding the inflation outlook is certainly no higher than at the October meeting, and at the end of the day, the policy decision and the minutes make clear that the overwhelming majority of participants had established “reasonable confidence” that inflation would rise to two percent over the medium term. Also, in the context of a milestone decision about whether or not to begin policy normalization, a robust discussion of risks to the inflation outlook was entirely appropriate. Anything less would have been surprising. Finally, we know from the “dot plot” in the December Summary of Economic Projections that two members still would have preferred delaying liftoff until 2016. The minutes may simply reveal the rationale for the policy preference of these more dovish Committee members, and of those who viewed December lift-off as appropriate but a “close call” nonetheless.

Instead, the main takeaway from the minutes concerns the conditions for further rate increases. In the post-meeting press conference, Chair Yellen alluded to the fact that the Committee would now want to see their confidence in the inflation outlook validated by the data. At the time, I interpreted this to mean that while “reasonable confidence” in the inflation outlook may have been a suitable condition for liftoff, actual progress towards the two percent inflation objective will be an equally if not more important condition for additional rate increases. The minutes are consistent with this interpretation, and appear to tie future rate increases more explicitly to progress on the inflation front than Yellen’s comments in the press conference:

In the current situation, because of their significant concern about still-low readings on actual inflation and the uncertainty and risks present in the inflation outlook, [members] agreed to indicate that the Committee would carefully monitor actual and expected progress toward its inflation goal. In determining the size and timing of further adjustments to monetary policy, some members emphasized the importance of confirming that inflation would rise as projected and of maintaining the credibility of the Committee’s inflation objective.”

In the near term, if base effects related to past dollar and energy price movements lead to some firming of inflation numbers, it would open the door to a rate increase at the March meeting. This remains my base case. However, there remains the possibility that the more recent dollar appreciation and oil price declines will serve to offset the year-over-year effects and give the Committee reason to delay beyond March.

Steven Friedman

Senior Investment Strategist

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