Fed Sees Next Hike Soon, Signals Modest Inflation Overshoot OK

(Bloomberg) -- Federal Reserve officials said the economic outlook warranted another interest-rate hike “soon” and signaled they would welcome a modest overshoot of their 2 percent inflation target, indicating they’re in no rush to tighten more aggressively.

“Most participants judged that if incoming information broadly confirmed their current economic outlook, it would likely soon be appropriate for the committee to take another step in removing policy accommodation,” minutes released Wednesday of the Federal Open Market Committee’s May 1-2 meeting said.

A temporary period of inflation “modestly above 2 percent would be consistent with the committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations,” according to the minutes.

While the report all but confirms the central bank is on track to raise interest rates at their next meeting in June, Fed officials were reluctant to declare victory on achieving their inflation goal on a sustainable basis. At the same time, they flagged potential changes to the statement at future meetings to indicate rates were no longer as stimulative, and discussed adjustments in the rate of interest on excess bank reserves to relieve some pressures in the money markets.

“It was noted that it was premature to conclude that inflation would remain at levels around 2 percent, especially after several years in which inflation had persistently run below the committee’s 2 percent objective,” the minutes said.

Symmetric Goal

At the meeting, U.S. central bankers left the target range for the benchmark policy rate unchanged at 1.5 percent to 1.75 percent after raising rates in March, and inserted a second reference to their “symmetric” 2 percent inflation goal in the policy statement on their decision.

Investors had already widely expected officials to raise rates when the FOMC meets June 12-13, according to interest-rate futures prices. Policy makers have been split on whether a total of three or four hikes are warranted for the full year.

Financial markets were unsettled in the days running up to the May FOMC meeting amid concerns over a U.S.-China trade dispute, with stock prices falling and 10-year Treasury yield rising toward 3 percent.

President Donald Trump has threatened tariffs on as much as $150 billion in Chinese imports, with China vowing to retaliate in kind. While the nations announced a truce over the weekend, Trump has since said he wasn’t pleased with the trade negotiations, and tweeted Wednesday that the U.S. may need to change the direction of talks to get a final agreement.

Policy makers relayed concerns from regional business contacts who warned of possible adverse effects from tariffs and trade restrictions, such as delays or pullbacks in capital spending.

In addition, “it was noted that the potential for higher Chinese tariffs on key agricultural products could, in the longer run, hurt U.S. competitiveness.”

Yield Curve

The minutes showed officials discussed the flattening yield curve, or the shrinking gap between the yields on long-dated Treasury bonds and short-term securities. That spread -- which turned negative in the run-up to every recession in the past 40 years -- has recently narrowed to around the lowest levels since 2007.

While a few policy makers said the yield curve may have become “a less reliable signal of future economic activity,” several others stressed that an inverted yield curve has historically “indicated an increased risk of recession,” according to the minutes.

Fed officials met after data showed price gains finally hitting their target after undershooting for most of the last few years. New York Fed President William Dudley and San Francisco’s John Williams, who’ll replace him next month, have both since said they’re comfortable with a modest inflation overshoot, signaling no rush to speed up the central bank’s gradual pace of policy tightening.

Preferred Measure

Inflation, according to the Fed’s preferred indicator, reached 2 percent in March. Data released two days after the meeting showed unemployment dipped in April to 3.9 percent, the lowest since 2000, while year-over-year gains in average hourly earnings were steady at 2.6 percent.

Officials largely viewed the economy as in good shape and anticipated that the first-quarter slowdown in consumer spending would prove temporary, according to the report. A few policy makers “emphasized the need to build additional resilience in the financial sector at this point in the economic expansion,” the minutes said, while noting that “leverage in the nonfinancial corporate sector remained elevated.”

Separately, Fed policy makers backed potentially making a “small technical adjustment” of setting the interest on excess reserves, or IOER, rate “modestly below” the top of the federal funds target range to help keep the effective fed funds rate “well within” range.

“Many participants judged that it would be useful to make such a technical adjustment sooner rather than later,” the minutes said.

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