Via Goldman's Jan Hatzius,
BOTTOM LINE: The July FOMC minutes generally had a slightly hawkish tone, emphasizing that labor market slack had improved faster than expected and that the labor market was now closer to what might be considered normal in the longer run. Separately, there was an extended discussion of exit strategy, at which the Board staff laid out a framework that was well received by meeting participants.
MAIN POINTS:
1. Regarding the assessment of the labor market, many Committee members agreed that a number of indicators of labor market conditions had "improved more in recent months than they had anticipated earlier." Many members further noted that the FOMC statement's "characterization of [significant] labor market underutilization might have to change before long, particularly if progress in the labor market continued to be faster than anticipated." The broader set of meeting participants agreed that the rate of improvement in the labor market had been faster than anticipated, and that "conditions had moved noticeably closer to those viewed as normal in the longer run." Overall, these remarks suggest that the change in the labor market language found in the July FOMC statement—shifting focus to broader labor market indicators rather than the unemployment rate specifically—was not intended to be a dovish change, as some commentators thought at the time. To the contrary, the discussion of labor market developments in the minutes had a hawkish tilt.
2. In a similar vein, the staff revised down its estimate of potential GDP growth, in light of the continued outperformance of labor market indicators despite disappointing GDP growth. This suggests that the staff reduced their estimate for the size of the output gap, a slightly hawkish signal.
3. The discussion on inflation was less substantive than on the labor market, with "most" participants now judging that downside risks had diminished. Committee members agreed that it was appropriate to recognize that inflation had moved closer to the Committee's objective in the statement, suggesting that they viewed the recent uptick in the inflation trend as having some staying power.
4. The recovery in housing was described as "slow" by most participants, facing headwinds such as high levels of student loan debt and tight access to credit. Some felt that "factors restraining residential construction might persist, damping the housing recovery for some time."
5. On financial imbalances, participants noted some evidence of stretched valuations in specific markets, but on the whole felt that the phenomenon was not widespread and that "vulnerabilities in the financial system were at low to moderate levels." This is consistent with prior communications from Fed officials.
6. There was an extended discussion of exit strategy. The staff presented a "possible approach," for which participants "expressed general support." Key aspects of the approach apparently included: (1) continuing to target a range of 25 basis points for the federal funds rate (i.e., the first hike could be a move to a target range of 25 - 50 basis points); (2) the top of the range would be set equal to the interest rate paid on excess reserves (IOER) and the bottom of the range set equal to the rate on the fixed-rate O/N RRP facility; (3) the size of the O/N RRP facility should "be only as large as needed to effective monetary policy implementation and should be phased out when it is no longer needed for that purpose"; and (4) most favored reducing or ending portfolio reinvestment after the first increase in the target range for the fed funds rate. Some felt that the O/N RRP rate should be set below the bottom of the target range, which would further discourage use of the facility, but many participants thought such a strategy would provide insufficient control over the level of rates.
