Brocker.Org: The Fed plans to raise rates ‘fairly soon’ if the economy cooperates

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41



Janet
Yellen

AP

The Federal Reserve plans to raise interest rates “fairly soon”
if the economy remains on track, according to minutes from
the January/February policy meeting released Wednesday.

At that
meeting
, the Federal Open Markets Committee voted to leave
its benchmark interest rate unchanged, just as markets had
expected. Wednesday’s minutes will be scrutinized for any clues
on when the FOMC is likely to raise interest rates again. 

It’s unlikely to be in March, even after recent hawkish
commentary from several Fed officials including Chair Janet
Yellen. According to Bloomberg, futures traders priced in a 38%
chance of a rate increase at the March 14-15 meeting, and a
60% chance of one at the gathering in June. 

There’s renewed interest in how the Fed plans to shrink its
balance sheet. After the recession, the Fed launched
bond-buying programs to keep help keep interest rates low, and
expanded its holdings to about $4.5 trillion as a result. 

“The shrinking of the balance sheet may start in the not too
distant future,” said Neel Kashkari, the Minneapolis Fed
president, on Tuesday. Yellen was similarly vague during
congressional testimony
on Valentine’s Day, saying the Fed
would gradually unwind its balance sheet when the process of
normalizing rates is well underway. 

“It is clear that policymakers have not reached a consensus
on the particulars of the Fed’s reinvestment policy at this
point,” said Deutsche Bank economists in a note on
Tuesday. Economists at BNP Paribas forecast that the Fed
will start trimming its balance sheet once rates are in the
1%-1.5% range; the benchmark Fed funds rate is in a range of
0.50%-0.75%.

Here’s the full
text
:

Illustration of Uncertainty in the Summary of Economic
Projections
Participants considered a revised proposal from the subcommittee
on communications to add to the Summary of Economic Projections
(SEP) a number of charts (sometimes called fan charts) that would
illustrate the uncertainty that attends participants’
macroeconomic projections. The revised proposal was based on
further analysis and consultations following Committee discussion
of a proposal at the January 2016 meeting. Participants generally
supported the revised approach and agreed that fan charts would
be incorporated in the SEP to be released with the minutes of the
March 14-15, 2017, FOMC meeting. The Chair noted that a staff
paper on measures of forecast uncertainty in the SEP, including
those that would be used as the basis for fan charts in the SEP,
would be made available to the public soon after the minutes of
the current meeting were published, and that examples of the new
charts using previously published data would be released in
advance of the March meeting.

Developments in Financial Markets and Open Market
Operations
The SOMA manager reported on developments in U.S. and global
financial markets during the period since the Committee met on
December 13-14, 2016. Financial asset prices were little changed
since the December meeting. Market participants continued to
report substantial uncertainty about potential changes in fiscal,
regulatory, and other government policies. Nonetheless, measures
of implied volatility of various asset prices remained low.
Emerging market currencies were generally resilient in recent
weeks, reportedly benefiting from investors’ anticipation of
stronger global economic growth, after depreciating significantly
against the dollar during the previous intermeeting period.
Market expectations for the path of the federal funds rate were
little changed over the intermeeting period.

The deputy manager followed with a briefing on developments in
money markets, market expectations for the System’s balance
sheet, and open market operations. In money markets, interest
rates smoothly shifted higher following the Committee’s decision
at its December meeting to increase the target range for the
federal funds rate by 25 basis points, and federal funds
subsequently traded near the center of the new range except on
year-end. Although year-end pressures in U.S. money markets were
similar to past quarter-ends, some notable, albeit temporary,
strains appeared over the turn of the year in foreign exchange
swap markets and European markets for repurchase agreements. The
Open Market Desk’s surveys of dealers and market participants
pointed to some change in expectations for FOMC reinvestment
policy, with more respondents than in previous surveys
anticipating a change in policy when the federal funds rate
reaches 1 to 1-1/2 percent. The higher level of take-up at the
System’s overnight reverse repurchase agreement facility that
developed following the implementation of money market fund
reform last fall generally persisted. The staff also briefed the
Committee on plans for small-value tests of various System
operations and facilities during 2017 and for quarterly tests of
the Term Deposit Facility.

By unanimous vote, the Committee ratified the Desk’s domestic
transactions over the intermeeting period. There were no
intervention operations in foreign currencies for the System’s
account during the intermeeting period.

Staff Review of the Economic Situation
The information reviewed for the January 31-February 1 meeting
indicated that real gross domestic product (GDP) expanded at a
moderate rate in the fourth quarter of last year and that labor
market conditions continued to strengthen. Consumer price
inflation rose further above the slow pace seen during the first
half of last year, but it was still running below the Committee’s
longer-run objective of 2 percent.

Recent indicators generally showed that labor market conditions
continued to improve in late 2016. Total nonfarm payroll
employment increased at a solid pace in December. The
unemployment rate edged up to 4.7 percent but remained near its
recent low, while the labor force participation rate rose
slightly. The share of workers employed part time for economic
reasons decreased further. The rates of private-sector job
openings and of hiring were unchanged in November, while the rate
of quits edged up. The four-week moving average of initial claims
for unemployment insurance benefits was still low in December and
early January. Measures of labor compensation continued to rise
at a moderate rate. The employment cost index for private
industry workers rose 2-1/4 percent over the 12 months ending in
December, and average hourly earnings for all employees increased
almost 3 percent over the same 12-month period. The unemployment
rates for African Americans, for Hispanics, and for whites were
close to the levels seen just before the most recent recession,
but the unemployment rates for African Americans and for
Hispanics remained above the rate for whites.

Total industrial production edged down in the fourth quarter as a
whole. Mining output expanded markedly, but manufacturing
production advanced only modestly. The output of utilities
declined, as the weather was unseasonably warm, on average,
during the fourth quarter. Automakers’ assembly schedules
suggested that motor vehicle production would be a little lower
early this year, but broader indicators of manufacturing
production, such as the new orders indexes from national and
regional manufacturing surveys, were consistent with modest gains
in factory output in the near term.

Real personal consumption expenditures (PCE) rose at a moderate
pace in the fourth quarter. Consumer expenditures for durable
goods, particularly motor vehicles, increased considerably.
However, consumer spending for energy services declined markedly,
reflecting unseasonably warm weather. Recent readings on some key
factors that influence consumer spending–including further gains
in employment, real disposable personal income, and households’
net worth–were consistent with moderate increases in real PCE in
early 2017. In addition, consumer sentiment, as measured by the
University of Michigan Surveys of Consumers, moved up to an
elevated level in December and January.

Real residential investment spending rose at a brisk pace in the
fourth quarter after decreasing in the previous two quarters.
Building permit issuance for new single-family homes–which tends
to be a reliable indicator of the underlying trend in
construction–advanced solidly. Sales of existing homes increased
modestly in the fourth quarter, although new home sales declined.

Real private expenditures for business equipment and intellectual
property (E&I) expanded at a moderate pace in the fourth
quarter after declining, on net, over the preceding three
quarters. Recent increases in nominal new orders of nondefense
capital goods excluding aircraft, along with improvements in
indicators of business sentiment, pointed to further moderate
increases in real E&I spending in the near term. Real
business expenditures for nonresidential structures declined in
the fourth quarter after rising in the previous quarter. The
number of crude oil and natural gas rigs in operation, an
indicator of spending for structures in the drilling and mining
sector, continued to increase through late January. The change in
real inventory investment was estimated to have made an
appreciable positive contribution to real GDP growth in the
fourth quarter.

Real total government purchases rose somewhat in the fourth
quarter. Federal government purchases for defense decreased while
nondefense expenditures increased. State and local government
purchases increased modestly, as the payrolls of these
governments expanded slightly and their construction spending
advanced somewhat.

The U.S. international trade deficit widened in November for the
second consecutive month. After declining in October, nominal
exports fell again in November as decreases in exports of capital
goods more than offset increases in exports of industrial
supplies. Nominal imports in November rose to their highest level
of the year, led by imports of industrial supplies and materials.
The Census Bureau’s advance trade estimates for December
suggested a narrowing of the trade deficit in goods, as imports
increased less than exports. Altogether, the change in real net
exports was estimated to have made a substantial negative
contribution to real GDP growth in the fourth quarter.

Total U.S. consumer prices, as measured by the PCE price index,
increased a little more than 1-1/2 percent over the 12 months
ending in December, partly restrained by decreases in consumer
food prices last year. Core PCE price inflation, which excludes
changes in food and energy prices, was 1-3/4 percent over those
same 12 months, held down in part by decreases in the prices of
non­energy imports over part of this period. Over the same
12-month period, total consumer prices as measured by the
consumer price index (CPI) rose a bit more than 2 percent, while
core CPI inflation was 2-1/4 percent. Survey-based measures of
median longer-run inflation expectations–such as those from the
Michigan survey and from the Desk’s Survey of Primary Dealers and
Survey of Market Participants–were unchanged, on net, over
December and January.

Foreign real GDP growth appeared to slow somewhat in the fourth
quarter from its relatively strong third-quarter pace.
Nevertheless, recent data on foreign industrial production and
trade seemed to be stronger than private analysts had anticipated
and were consistent with moderate economic growth abroad.
Economic growth in both the euro area and the United Kingdom
continued at relatively solid rates. In the emerging market
economies (EMEs), GDP growth remained robust in China but slowed
elsewhere in the Asian EMEs and in Mexico, while the pace of
economic contraction appeared to lessen in South America.
Inflation in the advanced foreign economies (AFEs) continued to
rise, largely reflecting the pass-through of earlier increases in
crude oil prices into retail energy prices. Inflation also rose
in many EMEs, in part because of rising food and fuel prices;
however, inflation fell notably in much of South America.

Staff Review of the Financial Situation
Domestic financial conditions were mostly little changed, on
balance, since the December FOMC meeting. Broad equity price
indexes fluctuated in a relatively narrow range and ended the
intermeeting period about unchanged. Nominal Treasury yields
moved up across most maturities in the days following the
December FOMC meeting but subsequently reversed and ended the
period little changed on net. Measures of inflation compensation
based on Treasury Inflation-Protected Securities (TIPS) rose
somewhat on balance. Amid notable volatility, the broad dollar
index declined slightly on net. Meanwhile, financing conditions
for nonfinancial businesses and households remained generally
accommodative.

Although the FOMC’s decision to raise the target range for the
federal funds rate to 1/2 to 3/4 percent at the December meeting
was widely anticipated in financial markets, contacts generally
characterized some of the communications associated with the FOMC
meeting as less accommodative than expected. In particular,
market commentaries highlighted the upward revision of 25 basis
points to the median projection for the federal funds rate at the
end of 2017 in the SEP. Nonetheless, the expected path of the
federal funds rate implied by futures quotes was little changed,
on net, since the December meeting. Market-based estimates
indicated that investors saw the probability of an increase in
the target range for the federal funds rate at the January
31-February 1 FOMC meeting as very low, and the estimated
probability of an increase in the target range at or before the
March meeting was about 25 percent. Consistent with readings
based on market quotes, results from the Desk’s January Survey of
Primary Dealers and Survey of Market Participants indicated that
the median respondent assigned a probability of about 25 percent
to the next increase in the target range occurring at or before
the March FOMC meeting. Market-based estimates of the probability
of an increase in the target range at or before the June meeting
were about 70 percent.

Yields on nominal Treasury securities increased across most
maturities following the December FOMC meeting, but they fell, on
balance, over the remainder of the intermeeting period. While
market commentary suggested that a number of factors contributed
to the decline, a clear catalyst was difficult to identify.
Treasury yields ended the period about unchanged and remained
significantly higher than just before the U.S. elections in
November. TIPS-based measures of inflation compensation edged up
over the intermeeting period.

Broad U.S. equity price indexes fluctuated in a relatively narrow
range and were little changed, on net, over the intermeeting
period. However, equity prices remained notably higher than just
before the November elections, apparently reflecting investors’
expectations that fiscal and other policy changes would boost
corporate profits and economic activity in the medium term.
Implied volatility on the S&P 500 index edged down since the
December meeting and remained relatively low. Corporate bond
spreads for both investment- and speculative-grade firms
continued to narrow over the intermeeting period and were near
the bottom of their ranges of the past several years.

Money market rates responded as expected to the change in the
target range for the federal funds rate. The effective federal
funds rate was 66 basis points–25 basis points higher than
previously–every day following the change, except at year-end.
Conditions in other domestic short-term funding markets were
generally stable over the intermeeting period. Assets under
management by money market funds changed little, with government
funds experiencing modest net outflows and prime fund assets
remaining about flat.

Financing conditions for nonfinancial businesses continued to be
accommodative overall. Corporate bond issuance by nonfinancial
firms rebounded in December to about its robust average pace of
the past few years, and issuance of syndicated leveraged loans
was strong. Gross equity issuance was solid in November and
December. Meanwhile, after a slowdown in the third quarter, the
growth of commercial and industrial (C&I) loans on banks’
books picked up in the fourth quarter, although the pace remained
slower than earlier in the year. The January Senior Loan Officer
Opinion Survey on Bank Lending Practices (SLOOS) indicated that
banks left C&I lending standards for large and middle-market
firms and for small firms unchanged, on balance, in the fourth
quarter. On net, banks expected to ease their standards for
C&I loans somewhat in 2017.

Credit continued to be broadly available in the commercial real
estate (CRE) sector, although results from the January SLOOS
indicated that banks continued to tighten their lending standards
in the fourth quarter and expected to tighten them somewhat
further in 2017. CRE loans on banks’ balance sheets continued to
grow in the fourth quarter, although at a somewhat slower rate
than earlier in the year, while issuance of commercial
mortgage-backed securities (CMBS) was solid over the period, in
part because issuers tried to complete deals before the
implementation of new risk retention rules in late December. The
delinquency rate on CMBS moved up further in November and
December; the increase largely reflected delinquencies on loans
originated before the financial crisis.

Credit conditions for residential mortgages were little changed,
on net, over the intermeeting period. Mortgage credit was broadly
available to households with average to high credit scores, while
credit remained tight for borrowers with low credit scores,
hard-to-document income, or high debt-to-income ratios. According
to the January SLOOS, banks reportedly left lending standards
unchanged, on net, on most categories of home-purchase loans. The
interest rate on 30-year fixed-rate mortgages moved about in line
with rates on comparable-maturity Treasury securities, rising
notably after the November elections but retracing part of that
increase since mid-December. The pace of purchase originations
was little changed in recent months despite higher mortgage
rates, while refinance originations fell sharply. Bank lending
for residential mortgages was solid in the fourth quarter, and
the issuance of mortgage-backed securities was robust.

Financing conditions in consumer credit markets remained
generally accommodative, although lending standards for credit
cards continued to be tight for subprime borrowers. Respondents
to the January SLOOS indicated that, over the previous three
months, they had tightened standards and terms on auto and credit
card loans, and that they expected to tighten standards further
in 2017. Consumer loan balances increased at a robust rate
through November, with credit card loans, student loans, and auto
loans all expanding at a similar pace. Measures of consumer
credit quality were little changed, on net, in the fourth
quarter.

Foreign economic data that were better than expected and
perceptions of an ebbing of some potential downside risks in
Europe appeared to contribute to an improvement in investor
sentiment in global financial markets. Importantly, a large
euro-area bank reached a settlement with the U.S. Department of
Justice on issues related to mortgage-backed securities, and the
Italian government approved a funding package and other measures
to support struggling banks. Reflecting the improved sentiment
and positive economic news, global equity prices and longer-term
sovereign yields in most AFEs increased moderately over the
period. Yield spreads on EME sovereign bonds narrowed somewhat,
and flows into EME mutual funds turned positive. The broad dollar
index increased immediately after the December FOMC meeting but
subsequently retraced its gains and ended the period slightly
lower. In contrast, the dollar strengthened further against the
Mexican peso over the intermeeting period.

The staff provided its latest report on potential risks to
financial stability, indicating that it continued to judge the
vulnerabilities of the U.S. financial system as moderate on
balance. The staff’s assessment took into account the increase in
asset valuation pressures since the November elections, the
overall low level of financial leverage, the strong capital
positions at banks, and the subdued growth of debt among
households and businesses. In addition, with money market fund
reforms in place, the vulnerabilities from maturity and liquidity
transformation were viewed as being somewhat below their
longer-run average.

Staff Economic Outlook
In the U.S. economic projection prepared by the staff for this
FOMC meeting, the near-term forecast was little changed from the
December meeting. Real GDP growth in the fourth quarter of last
year was estimated to have been a little faster than the staff
had expected in December, and the pace of economic growth in the
first half of this year was projected to be essentially the same
as in the fourth quarter. The staff’s forecast for real GDP
growth over the next several years was little changed. The staff
continued to project that real GDP would expand at a modestly
faster pace than potential output in 2017 through 2019. The
unemployment rate was forecast to edge down gradually through the
end of 2019 and to run below the staff’s estimate of its
longer-run natural rate; the path for the unemployment rate was
little changed from the previous projection.

The staff’s forecast for consumer price inflation was unchanged
on balance. The staff continued to project that inflation would
increase over the next several years, as food and energy prices,
along with the prices of non-energy imports, were expected to
begin steadily rising either this year or next. However,
inflation was projected to be marginally below the Committee’s
longer-run objective of 2 percent in 2019.

The staff viewed the uncertainty around its projections for real
GDP growth, the unemployment rate, and inflation as similar to
the average of the past 20 years. The risks to the forecast for
real GDP were seen as tilted to the downside, primarily
reflecting the staff’s assessment that monetary policy appeared
to be better positioned to offset large positive shocks than
substantial adverse ones. However, the staff viewed the risks to
the forecast from developments abroad as less pronounced than in
the recent past. Consistent with the downside risks to aggregate
demand, the staff viewed the risks to its outlook for the
unemployment rate as tilted to the upside. The risks to the
projection for inflation were seen as roughly balanced. The
downside risks from the possibility that longer-term inflation
expectations may have edged down or that the dollar could
appreciate substantially further were seen as roughly
counterbalanced by the upside risk that inflation could increase
more than expected in an economy that was projected to continue
operating above its longer-run potential.

Participants’ Views on Current Conditions and the Economic
Outlook
In their discussion of the economic situation and the outlook,
meeting participants agreed that information received over the
intermeeting period indicated that the labor market had continued
to strengthen and that economic activity had continued to expand
at a moderate pace. Job gains had remained solid, and the
unemployment rate had stayed near its recent low. Household
spending had continued to rise moderately, while business fixed
investment had remained soft. Measures of consumer and business
sentiment had improved of late. Inflation had increased in recent
quarters but was still below the Committee’s 2 percent longer-run
objective. Market-based measures of inflation compensation
remained low; most survey-based measures of inflation
compensation were little changed on balance.

Participants generally indicated that their economic forecasts
had changed little since the December FOMC meeting. They
continued to anticipate that, with gradual adjustments in the
stance of monetary policy, economic activity would expand at a
moderate pace, labor market conditions would strengthen somewhat
further, and inflation would rise to 2 percent over the medium
term. They also judged that near-term risks to the economic
outlook appeared roughly balanced. Participants again emphasized
their considerable uncertainty about the prospects for changes in
fiscal and other government policies as well as about the timing
and magnitude of the net effects of such changes on economic
activity. In discussing the risks to the economic outlook,
participants continued to view the possibility of more
expansionary fiscal policy as having increased the upside risks
to their economic forecasts, although some noted that several
potential changes in government policies could pose downside
risks. In addition, several viewed the downside risks from weaker
economic activity abroad as having diminished somewhat. But
several indicated that they continued to be concerned about the
downside risks to economic activity associated with the
possibility of additional appreciation of the foreign exchange
value of the dollar or financial vulnerabilities in some foreign
economies, together with the proximity of the federal funds rate
to the effective lower bound. Regarding the outlook for
inflation, some participants continued to be concerned that
faster-than-expected economic growth or a substantial
undershooting of the longer-run normal unemployment rate posed
upside risks to inflation. However, several others continued to
see downside risks to the inflation outlook, citing still-low
measures of inflation compensation and inflation expectations or
the possibility of further appreciation of the dollar.
Participants generally agreed that the Committee should continue
to closely monitor inflation indicators and global economic and
financial developments.

Regarding the household sector, consumer spending posted a
moderate increase in the fourth quarter, and participants
generally anticipated that further gains in consumer spending
would contribute importantly to economic growth in 2017. They
expected that, although interest rates had moved higher,
household spending would continue to be supported by rising
employment and income as well as high levels of household wealth.
The recent improvement in consumer sentiment was also viewed as a
potentially positive factor in the outlook for spending, although
several participants cautioned that an elevated level of
sentiment, even if it was sustained, was likely to make only a
small contribution to household spending beyond those from
income, wealth, and credit conditions.

Recent indicators of activity in the housing sector were
generally positive. Starts and permits for single-family housing
and sales of existing homes rose moderately in the fourth
quarter, and real residential investment bounced back after two
quarterly declines. A couple of participants commented that
supply constraints might be holding back new homebuilding. In
addition, a few participants noted that prospects for residential
investment would also depend on whether household formation
picked up and how housing market activity responded to the recent
rise in mortgage interest rates.

The outlook for the business sector improved further over the
intermeeting period. Business investment in E&I, which had
been contracting earlier in 2016, increased at a moderate rate in
the fourth quarter. In addition, new orders for nondefense
capital goods posted widespread gains in recent months. The
available reports from District surveys of activity and revenues
in the manufacturing and services industries were very positive.
Moreover, a number of national surveys of sentiment among
corporate executives and small business owners as well as
information from participants’ District contacts indicated a high
level of optimism about the economic outlook. Many participants
indicated that their business contacts attributed the improvement
in business sentiment to the expectation that firms would benefit
from possible changes in federal spending, tax, and regulatory
policies. A few participants indicated that some of their
contacts had already increased their planned capital
expenditures. However, participants’ contacts in some Districts,
while optimistic, intended to wait for more clarity about federal
policy initiatives before adjusting their capital spending and
hiring. In addition, contacts in some industries remained
concerned that their businesses might be adversely affected by
some of the government policy changes being considered. Activity
in the energy sector continued to improve, with District contacts
reporting an increase in capital spending, better access to
credit, and a pickup in hiring. However, reports from a couple of
Districts indicated that the agricultural sector was still weak,
with low commodity prices continuing to put financial pressure on
farm-related businesses.

The labor market continued to strengthen in recent months.
Monthly gains in nonfarm payroll employment averaged 165,000 over
the period from October to December, a pace that, if it
continued, would be expected to increase labor utilization over
time. At 4.7 percent in December, the unemployment rate remained
close to levels that most participants judged to be consistent
with the Committee’s maximum-employment objective. Some
participants cited other indicators confirming the strengthening
in the labor market, such as a decline in the broader measures of
labor underutilization that include workers marginally attached
to the labor force, the rise in the quits rate, and faster
increases in some measures of labor compensation. Moreover,
several participants’ business contacts reported shortages of
workers in some occupations or the need for training programs to
expand the supply of skilled workers. Several other participants
thought that some margins of labor underutilization remained,
citing the still-high rate of prime-age workers outside the labor
force, the elevated share of workers who were employed part time
for economic reasons, or the potential for further firming in
labor force participation. However, a couple of participants
pointed out that the uncertainty attending estimates of
longer-run trends in part-time employment and labor force
participation made it difficult to assess the scope for
additional increases in labor utilization. Most participants
still expected that if economic growth remained moderate, labor
markets would continue to tighten gradually, with the
unemployment rate running only modestly below their estimates of
the longer-run normal rate. However, several participants
projected a more substantial undershooting.

Information on inflation received over the intermeeting period
was broadly in line with participants’ expectations and was
consistent with a view that PCE inflation was moving closer to
the Committee’s 2 percent objective. The 12-month change in
headline PCE prices increased further, to 1.6 percent in
December, as the effects of the earlier declines in consumer
energy prices waned. The 12-month change in core PCE prices
stayed near 1.7 percent for a fifth consecutive month. A few
participants noted that other measures provided additional
evidence that inflation was approaching the Committee’s
objective; for example, the 12-month changes in the headline and
core CPI, the median CPI, and the trimmed mean PCE price index
had also moved up from year-earlier levels. The available
information on pricing from District business contacts varied,
with a couple of participants reporting that firms were
experiencing rising cost pressures from input costs or had been
able to raise their prices, while a few other participants said
that firms in their Districts were not experiencing price
pressures or that the appreciation of the dollar was continuing
to hold down import prices. Most survey-based measures of
longer-term inflation expectations had been little changed in
recent months. The median response to the Michigan survey of
longer-run inflation expectations moved back up to 2.6 percent in
January, in line with the average of readings during 2016, and
the measure at the three-year horizon from the Federal Reserve
Bank of New York’s survey rose slightly in December; the measures
calculated by the Federal Reserve Bank of Cleveland had been
stable over the preceding three months. Some market-based
measures of inflation compensation had turned up noticeably in
late 2016, but a number of participants noted that they remained
relatively low. Most participants continued to expect that
inflation would rise to the Committee’s 2 percent objective over
the medium term. Some saw a risk that inflationary pressures
might develop more rapidly than currently anticipated as resource
utilization tightened, while several others thought that progress
in achieving the Committee’s inflation objective might lag if
further appreciation of the dollar continued to depress
non-energy commodity prices or if inflation was slow to respond
to tighter resource utilization.

Financial conditions appeared to have changed little, on net, in
recent months: Equity prices had risen and credit spreads had
narrowed, but longer-term interest rates had increased and the
dollar had appreciated further. In their discussion, participants
considered how recent developments had affected their assessment
of the stability of the U.S. financial system. Overall, valuation
pressures appeared to have risen for some types of assets, while
financial-sector leverage remained low and risks associated with
maturity and liquidity transformation had declined. A few
participants commented that the recent increase in equity prices
might in part reflect investors’ anticipation of a boost to
earnings from a cut in corporate taxes or more expansionary
fiscal policy, which might not materialize. They also expressed
concern that the low level of implied volatility in equity
markets appeared inconsistent with the considerable uncertainty
attending the outlook for such policy initiatives.

Recent reforms had diminished the risk of runs on or by prime
money market funds. However, it was noted that other risks to
financial stability might arise as the structure of funding
markets evolved or if real estate asset values declined sharply.
More broadly, it was pointed out that an environment of low
interest rates and a relatively flat yield curve, if it
persisted, had the potential to boost incentives to take on
leverage and risk. Several participants emphasized that the
increased resilience of the financial system since the financial
crisis had importantly been the result of the key safety and
soundness reforms put in place in recent years. However, having
additional macroprudential tools could prove useful in addressing
problems that could arise in real estate financing or in the
shadow banking sector.

Participants discussed whether their current assessments of
economic conditions and the medium-term outlook warranted
altering their earlier views of the appropriate path for the
target range for the federal funds rate. Participants generally
characterized their economic forecasts and their judgments about
monetary policy as little changed since the December meeting.
Against this backdrop, they thought it appropriate to maintain
the target range for the federal funds rate at 1/2 to 3/4 percent
at this meeting.

Most participants continued to judge that, while the outlook was
subject to considerable uncertainty, a gradual pace of rate
increases over time was likely to be appropriate to promote the
Committee’s objectives of maximum employment and 2 percent
inflation. Some participants viewed a gradual pace as likely to
be warranted because inflation was still running below the
Committee’s objective or because the proximity of the federal
funds rate to the effective lower bound placed constraints on the
ability of monetary policy to respond to adverse shocks to the
aggregate demand for goods and services. In addition, it was
noted that the downward pressure on longer-term interest rates
exerted by the Federal Reserve’s asset holdings was expected to
diminish in the years ahead in light of an anticipated gradual
reduction in the size and duration of the Federal Reserve’s
balance sheet. Finally, the view that gradual increases in the
federal funds rate were likely to be appropriate also reflected
the assessment that the neutral real rate–defined as the real
interest rate that is neither expansionary nor contractionary
when the economy is operating at or near its potential–was
currently quite low and was likely to rise only slowly over time.

Participants emphasized that the Committee might need to change
its communications regarding the anticipated path for the policy
rate if economic conditions evolved differently than the
Committee expected or if the economic outlook changed. They
pointed to a number of risks that, if realized, might call for a
different policy trajectory than they currently thought most
likely to be appropriate. These included upside risks such as
appreciably more expansionary fiscal policy or a more rapid
buildup of inflationary pressures, as well as downside risks
associated with a possible further appreciation of the dollar or
financial vulnerabilities in some foreign economies, together
with the proximity of the federal funds rate to the effective
lower bound. Moreover, most participants continued to see
heightened uncertainty regarding the size, composition, and
timing of possible changes to fiscal and other government
policies, and about their net effects on the economy and
inflation over the medium term, and they thought some time would
likely be required for the outlook to become clearer. A couple of
participants argued that such uncertainty should not deter the
Committee from taking further steps in the near term to remove
monetary policy accommodation, because fiscal and other policies
were only some of the many factors that were likely to influence
progress toward the Committee’s dual-mandate objectives and thus
the appropriate course of monetary policy. However, other
participants cautioned against adjusting monetary policy in
anticipation of policy proposals that might not be enacted or
that, if enacted, might turn out to have different consequences
for economic activity and inflation than currently anticipated.

In discussing the outlook for monetary policy over the period
ahead, many participants expressed the view that it might be
appropriate to raise the federal funds rate again fairly soon if
incoming information on the labor market and inflation was in
line with or stronger than their current expectations or if the
risks of overshooting the Committee’s maximum-employment and
inflation objectives increased. A few participants noted that
continuing to remove policy accommodation in a timely manner,
potentially at an upcoming meeting, would allow the Committee
greater flexibility in responding to subsequent changes in
economic conditions. Several judged that the risk of a sizable
undershooting of the longer-run normal unemployment rate was
high, particularly if economic growth was faster than currently
expected. If that situation developed, the Committee might need
to raise the federal funds rate more quickly than most
participants currently anticipated to limit the buildup of
inflationary pressures. However, with inflation still short of
the Committee’s objective and inflation expectations remaining
low, a few others continued to see downside risks to inflation or
anticipated only a gradual return of inflation to the 2 percent
objective as the labor market strengthened further. A couple of
participants expressed concern that the Committee’s
communications about a gradual pace of policy firming might be
misunderstood as a commitment to only one or two rate hikes per
year and stressed the importance of communicating that policy
will respond to the evolving economic outlook as appropriate to
achieve the Committee’s objectives. Participants also generally
agreed that the Committee should begin discussions at upcoming
meetings about the economic conditions that could warrant changes
in the existing policy of reinvesting proceeds from maturing
Treasury securities and principal payments from agency debt and
mortgage-backed securities, as well as how those changes would be
implemented and communicated.

Committee Policy Action
In their discussion of monetary policy for the period ahead,
members judged that the information received since the Committee
met in December indicated that the labor market had continued to
strengthen and that economic activity had continued to expand at
a moderate pace. Job gains had remained solid, and the
unemployment rate had stayed near its recent low. Household
spending had continued to rise moderately, while business fixed
investment had remained soft. Measures of consumer and business
sentiment had improved of late. Inflation had increased in recent
quarters but was still below the Committee’s 2 percent longer-run
objective. Market-based measures of inflation compensation
remained low; most survey-based measures of longer-term inflation
expectations were little changed on balance.

With respect to the economic outlook and its implications for
monetary policy, members continued to expect that, with gradual
adjustments in the stance of monetary policy, economic activity
would expand at a moderate pace and labor market conditions would
strengthen somewhat further. Members agreed that there was
heightened uncertainty about the effects of possible changes in
fiscal and other government policies, but that near-term risks to
the economic outlook appeared roughly balanced. Many members
continued to see only a modest risk of a scenario in which the
unemployment rate would substantially undershoot its longer-run
normal level and inflation pressures would increase
significantly. These members expressed the view that inflation
was likely to rise toward 2 percent gradually, and that
policymakers would likely have ample time to respond if signs of
rising inflationary pressures did begin to emerge. Other members
indicated that if the labor market appeared to be tightening
significantly more than anticipated or if inflation pressures
appeared to be developing more rapidly than expected as resource
utilization tightened, it might become necessary to adjust the
Committee’s communications about the expected path of the federal
funds rate. One member noted that, even if incoming data on the
economy and inflation were consistent with expectations, taking
the next step in reducing policy accommodation relatively soon
would give the Committee greater flexibility in calibrating
policy to evolving economic conditions.

At this meeting, members continued to expect that, with gradual
adjustments in the stance of monetary policy, inflation would
rise to the Committee’s 2 percent objective over the medium term.
This view was reinforced by the rise in inflation and increases
in inflation compensation in recent months. Against this backdrop
and in light of the current shortfall in inflation from 2
percent, members agreed that they would continue to closely
monitor actual and expected progress toward the Committee’s
inflation goal.

After assessing current conditions and the outlook for economic
activity, the labor market, and inflation, members agreed to
maintain the target range for the federal funds rate at 1/2 to
3/4 percent. They judged that the stance of monetary policy
remained accommodative, thereby supporting some further
strengthening in labor market conditions and a return to 2
percent inflation.

The Committee agreed that, in determining the timing and size of
future adjustments to the target range for the federal funds
rate, it would assess realized and expected economic conditions
relative to its objectives of maximum employment and 2 percent
inflation. This assessment would take into account a wide range
of information, including measures of labor market conditions,
indicators of inflation pressures and inflation expectations, and
readings on financial and international developments. The
Committee expected that economic conditions would evolve in a
manner that would warrant only gradual increases in the federal
funds rate and that the federal funds rate was likely to remain,
for some time, below levels expected to prevail in the longer
run. However, members emphasized that the actual path of the
federal funds rate would depend on the evolution of the economic
outlook as informed by incoming data.

The Committee also decided to maintain its existing policy of
reinvesting principal payments from its holdings of agency debt
and agency mortgage-backed securities in agency mortgage-backed
securities and of rolling over maturing Treasury securities at
auction, and it anticipated doing so until normalization of the
level of the federal funds rate is well under way. Members noted
that this policy, by keeping the Committee’s holdings of
longer-term securities at sizable levels, should help maintain
accommodative financial conditions.

At the conclusion of the discussion, the Committee voted to
authorize and direct the Federal Reserve Bank of New York, until
it was instructed otherwise, to execute transactions in the SOMA
in accordance with the following domestic policy directive, to be
released at 2:00 p.m.:

“Effective February 2, 2017, the Federal Open Market Committee
directs the Desk to undertake open market operations as necessary
to maintain the federal funds rate in a target range of 1/2 to
3/4 percent, including overnight reverse repurchase operations
(and reverse repurchase operations with maturities of more than
one day when necessary to accommodate weekend, holiday, or
similar trading conventions) at an offering rate of 0.50 percent,
in amounts limited only by the value of Treasury securities held
outright in the System Open Market Account that are available for
such operations and by a per-counterparty limit of $30 billion
per day.

The Committee directs the Desk to continue rolling over maturing
Treasury securities at auction and to continue reinvesting
principal payments on all agency debt and agency mortgage-backed
securities in agency mortgage-backed securities. The Committee
also directs the Desk to engage in dollar roll and coupon swap
transactions as necessary to facilitate settlement of the Federal
Reserve’s agency mortgage-backed securities transactions.”

The vote also encompassed approval of the statement below to be
released at 2:00 p.m.:

“Information received since the Federal Open Market Committee met
in December indicates that the labor market has continued to
strengthen and that economic activity has continued to expand at
a moderate pace. Job gains remained solid and the unemployment
rate stayed near its recent low. Household spending has continued
to rise moderately while business fixed investment has remained
soft. Measures of consumer and business sentiment have improved
of late. Inflation increased in recent quarters but is still
below the Committee’s 2 percent longer-run objective.
Market-based measures of inflation compensation remain low; most
survey-based measures of longer-term inflation expectations are
little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to
foster maximum employment and price stability. The Committee
expects that, with gradual adjustments in the stance of monetary
policy, economic activity will expand at a moderate pace, labor
market conditions will strengthen somewhat further, and inflation
will rise to 2 percent over the medium term. Near-term risks to
the economic outlook appear roughly balanced. The Committee
continues to closely monitor inflation indicators and global
economic and financial developments.

In view of realized and expected labor market conditions and
inflation, the Committee decided to maintain the target range for
the federal funds rate at 1/2 to 3/4 percent. The stance of
monetary policy remains accommodative, thereby supporting some
further strengthening in labor market conditions and a return to
2 percent inflation.

In determining the timing and size of future adjustments to the
target range for the federal funds rate, the Committee will
assess realized and expected economic conditions relative to its
objectives of maximum employment and 2 percent inflation. This
assessment will take into account a wide range of information,
including measures of labor market conditions, indicators of
inflation pressures and inflation expectations, and readings on
financial and international developments. In light of the current
shortfall of inflation from 2 percent, the Committee will
carefully monitor actual and expected progress toward its
inflation goal. The Committee expects that economic conditions
will evolve in a manner that will warrant only gradual increases
in the federal funds rate; the federal funds rate is likely to
remain, for some time, below levels that are expected to prevail
in the longer run. However, the actual path of the federal funds
rate will depend on the economic outlook as informed by incoming
data.

The Committee is maintaining its existing policy of reinvesting
principal payments from its holdings of agency debt and agency
mortgage-backed securities in agency mortgage-backed securities
and of rolling over maturing Treasury securities at auction, and
it anticipates doing so until normalization of the level of the
federal funds rate is well under way. This policy, by keeping the
Committee’s holdings of longer-term securities at sizable levels,
should help maintain accommodative financial conditions.”

Voting for this action: Janet L. Yellen, William C. Dudley, Lael
Brainard, Charles L. Evans, Stanley Fischer, Patrick Harker,
Robert S. Kaplan, Neel Kashkari, Jerome H. Powell, and Daniel K.
Tarullo.

Voting against this action: None.

Consistent with the Committee’s decision to leave the target
range for the federal funds rate unchanged, the Board of
Governors voted unanimously to leave the interest rates on
required and excess reserve balances unchanged at 0.75 percent
and voted unanimously to approve establishment of the primary
credit rate (discount rate) at the existing level of 1.25
percent.6

It was agreed that the next meeting of the Committee would be
held on Tuesday-Wednesday, March 14-15, 2017. The meeting
adjourned at 10:05 a.m. on February 1, 2017.

Notation Vote
By notation vote completed on January 3, 2017, the Committee
unanimously approved the minutes of the Committee meeting held on
December 13-14, 2016.


More to come …
  

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