Fed leans toward faster pace of interest rate hikes even as trade war poses risk
Federal Reserve officials leaned toward a slightly faster pace of tightening at their March meeting as their growth outlook and confidence in hitting their inflation target strengthened, according to minutes released Wednesday.
“A number of participants indicated that the stronger outlook for economic activity, along with their increased confidence that inflation would return to 2 per cent over the medium term, implied that the appropriate path for the federal funds rate over the next few years would likely be slightly steeper than they had previously expected,” the Federal Open Market Committee said in the records of its March 20-21 meeting.
At the gathering, the first under Chairman Jerome Powell, Fed officials lifted interest rates by a quarter percentage point and mostly penciled in two or three more moves this year. Even with the improved outlook, a “strong majority” of Fed officials voiced concern that a trade war would harm the economy, and some policy makers said the recent turbulence in financial markets highlighted risks to growth, the minutes showed.
“Participants did not see the steel and aluminum tariffs, by themselves, as likely to have a significant effect on the national economic outlook,” the minutes said. “But a strong majority of participants viewed the prospect of retaliatory trade actions by other countries” as a downside risk.
Investors saw about a 78 per cent chance that interest rates will be higher after the June meeting, according to federal funds futures prices at 12:40 p.m. New York time. The central bank’s current target is a range of 1.5 per cent to 1.75 per cent, after the March hike.
Above Potential
U.S. central bankers saw costs and benefits to an economy operating “well above potential,” ranging from a faster return of inflation to target and an increase in labor force participation. “On the other hand, an overheated economy could result in significant inflation pressures or lead to financial instability,” the minutes said.
The minutes showed participants discussed the possibility of revising statement language “at some point” to acknowledge that monetary policy “would likely gradually move from an accommodative stance to being a neutral or restraining factor for economic activity.”
Officials gathered to discuss policy with more powerful cross- currents than usual buffeting the U.S. economy.
Tax cuts have lifted business sentiment and the outlook for growth, with the Fed seeing a “significant boost to output over the next few years” from the tax law and a federal budget boost. At the same time, a few officials “noted that the changes in tax policy could boost the level of potential output,” the minutes said.
Yet a simmering U.S.-China trade dispute has roiled markets in recent weeks and tightened financial conditions, which could argue for going slower.
Trade Tensions
As the FOMC deliberated, the Trump administration was considering tariffs on Chinese imports, the prospect of which sent U.S. stocks tumbling by close to 6 per cent that week, after a volatile February thanks in part to an unexpectedly strong reading on wages. Equities have since recouped some of those losses amid signs of eased trade tensions.
“Many participants reported that their contacts had taken the previous month’s turbulence in stride, although a few participants suggested that financial developments over the intermeeting period highlighted some downside risks associated with still-high valuations for equities or from market volatility more generally,” the minutes said.
At the meeting, central bankers raised their median estimates for U.S. growth to 2.7 per cent for 2018 from 2.5 per cent projected in December.
They also saw the jobless rate falling to 3.6 per cent by the end of 2019, further below their 4.5 per cent estimate of unemployment’s long-run sustainable rate. The rate was 4.1 per cent in March, holding at the lowest since 2000.
Even with the strengthening labor market, most officials “still described the pace of wage gains as moderate,” according to the minutes. “A few participants cited this fact as suggesting that there was room for the labour market to strengthen somewhat further.”