Goldman's Fed Minutes Post-Mortem: "The Elephant Was In The Room After All"

Earlier we showed what some of the more prominent sellside strategists thought of the FOMC's surprisingly hawkish (yet maybe not) December minutes. And now, to top off the Fed Minutes day, here is perhaps the only analysis that matters: that of Goldman Sachs, which notes that as we speculated in December when the Fed hiked, "the hawkish December FOMC statement and accompanying increase in median interest rate expectations were to some extent motivated by the possibility of easier fiscal policy–as opposed to a shift in the FOMC reaction function."

From Goldman's Jan Hatzius

FOMC Minutes Show the Elephant Was in the Room After All 

 

BOTTOM LINE: Minutes from the December FOMC meeting suggest that the hawkish December FOMC statement and accompanying increase in median interest rate expectations were to some extent motivated by the possibility of easier fiscal policy–as opposed to a shift in the FOMC reaction function. 

 

MAIN POINTS:

 

1. Minutes from the December FOMC meeting indicated that the Board staff and “about half” of FOMC participants incorporated preliminary assumptions about fiscal easing into their projections. However, the staff noted that the impact of easier fiscal policy was “substantially counterbalanced by the restraint from the higher assumed paths for longer-term interest rates and the foreign exchange value of the dollar.” The offset from tighter financial conditions may also explain why median forecasts for GDP growth were little changed in participants’ Summary of Economic Projections (SEP).

 

2. Although officials’ baseline views on the economy were little changed, most appeared more confident about the balance of risks. In the summary included in the minutes, four officials saw risks to GDP growth as skewed to the upside and one saw risks as tilted to the downside. In September these figures were reversed, with four participants seeing downside risks and only one seeing upside risks (results were similar for officials’ views on inflation). A more favorable assessment of the balance of risks may have played a role in the upward revisions to several officials’ funds rate projections at the meeting

 

3. In addition, officials noted the low level of the unemployment rate and discussed the risk of a further undershooting relative to its longer-run sustainable rate. The minutes noted: “Many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures.” However, other officials cautioned that inflation was still below target and there could be benefits to a “moderate undershooting,” with some additional participants seeing scope to reduce “remaining margins of underutilization” through an extended period of relatively tight labor markets.

 

4. In terms of other relevant takeaways, a few participants suggested part of the recent decline in the unemployment rate might be reversed “in coming months.” Also of note, a “couple” participants worried that the term “gradual” might be misunderstood “as a commitment to only one or two rate hikes per year.” Lastly, several participants noted that the evolving outlook could have implications for both the path of rate increases as well as the structure of the balance sheet. In our view the December minutes contain relatively little guidance about the near-term policy outlook. We expect the next rate increase in June, and see a 35% chance that the FOMC moves as soon as March.