The Daily Update - Fed minutes and medium / long term inflation outlook

Wall Street stocks rose, the dollar (DXY Index) touched a two week low earlier today and US Treasury 10-year yields shaved a couple of basis points following the release of the Federal Reserve’s September meeting minutes. These further confirmed expectations that interest rates could still be increased once more this year despite the notable dovish tone.

Although “staff continued to project that inflation would edge higher in the next couple of years and that it would reach the Committee’s longer-run objective in 2019”… “The risks to the projection for inflation were also seen as balanced.” The minutes also noted that, “the recent run of soft inflation readings could prove to be more persistent” noting that “the influence of technological innovations on competition and business pricing, also might have been muting inflationary pressures and could be intensifying.” But also highlighting that “cyclical pressures associated with a tightening labor market or an economy operating above its potential were likely to show through to higher inflation over the medium term” with “at least part of the softening in inflation this year was the result of idiosyncratic or one-time factors.”

Tomorrow’s and ongoing inflation data will still be important as “Participants generally agreed it would be important to monitor inflation developments closely” even if it is difficult to decipher given “the temporary run-up in energy costs and… storm-related disruptions and rebuilding.” As we already know “nearly all supported… a gradual approach to increasing the federal funds rate” but the minutes made it clear that consistent with such a “gradual approach” many participants still thought that “another increase in the target range later this year was likely to be warranted if the medium-term outlook remained broadly unchanged.”

Such were the main inflation comments from the Fed’s 30 pages of minutes and economic projections from September’s meeting. The broader market grasp from all this is that–policymakers’ concerns for non-transitory inflation are more substantial than previously thought. It will be interesting to see the CPI data tomorrow and how the markets react to it; but in reality it may just take more time for the medium term inflation picture to become clearer whilst one monitors for both upward AND downward signals. Importantly, as we’ve mentioned before, “While we see the forecast of a rate hike this year and 3 next year as aggressive the shift down in the longer term ‘dot plot’ projections is supportive of our preference to be positioned at the longer end of the curve.” The Longer Term Implied Fed Funds Target Rate (extrapolated from the Fed Dots plot) at 2.75% is now at its lowest ever with five voting members estimating that the long-term target rate is now 2.5% or below and a lone optimistic outlier at 3.5% (in contrast to early 2012 when the median was above 4% with only 1 member expecting longer rates as low as 3.75%).

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