As expected, not much new in the FOMC minutes from the June meeting, as Yellen was quite clear during the press conference after the policy announcement and most FOMC members have expressed their views in speeches and/or interviews afterwards.
The most interesting part of the minutes was about the timing of the balance sheet run-off, as ‘several preferred to announce a start to the process within a couple of months’, if the economy evolves as expected. ‘Some’ want to wait until later in the year. Overall, it supports our view that the Fed can make an announcement in September and start actual run-off in Q4. Although the Fed recognises that the size of the balance sheet must be higher now than pre-crisis, as demand for central bank reserves has increased due to increasing financial regulation (see Research US: Fed’s regulatory hurdle for starting quantitative tightening, 13 March), the risk remains that the Fed is too optimistic about how much it can shrink the balance sheet. That said, we still do not know what level of the balance sheet the Fed aims at.
With respect to inflation, the minutes say low inflation is likely ‘transitory’, in line with what Fed Chair Yellen said at the press conference. Fed still has faith in the Phillips curve, which says that the tighter labour market should push up wage growth eventually. The problem is that tightness of the labour market is not the only factor determining wage growth, as second-round effects from the many years with inflation below 2% have hit wage growth. When employees expect to remain low, they can live with low wage growth, as real wage growth may still be solid, see also Strategy: Central banks consider leaving the party, 30 June.
We expect the Fed to hike one more time this year in December due to the focus on the unemployment rate and easy financial conditions. Note, though, that four FOMC members signalled no further hikes this year in the updated projections in connection with the June meeting. By skipping September, the Fed can also get some more clarification about whether the low inflation prints in recent months were temporary or not. Instead, we expect an announcement on the balance sheet in September as written in the second bullet. We still think risks are skewed towards the Fed pausing its hiking cycle next year,
