FOMC Minutes: Members Urged Attentions on Yield Curve, Change in Forward Guidance

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The FOMC minutes for the June meeting revealed that the members were confident over the growth and inflation outlook, although they acknowledged intensifying trade conflicts. There were discussions over the term structure of interest rates. While many of them were concerned over the flattening of US treasury yield curve, they believed the structure should be interpreted differently from previously, as the lengthened QE adopted in the aftermath of the global financial crisis has distorted the structure. On the policy language, the members raised the prospect of amending the rhetoric of “accommodative” monetary policy, replacing with, say, “neutral” after several times of gradual rate hikes.

On domestic developments, the members judged that the economy is “very strong” and inflation is “expected to run at 2% on a sustained basis over the medium term”. However, there were discussions about the recent intensification of trade war. As suggested in the minutes, “most participants noted that uncertainty and risks associated with trade policy had intensified and were concerned that such uncertainty and risks eventually could have negative effects on business sentiment and investment spending”.

Strong economic developments in the US have raised hopes of faster pace of Fed funds rate hike. This has lifted short-term Treasury yields more rapidly than long-term ones, resulting in the flattening of yield curve. Given historical correlation between inverted yield curve and economic recession, Fed members had extensive discussion at this meeting. The members noted a number of factors (besides rate hikes) that could contribute to a reduction in the spread between long-term and short-term Treasury yields, including “a reduction in investors’ estimates of the longer-run neutral real interest rate; lower longer-term inflation expectations; or a lower level of term premiums in recent years relative to historical experience reflecting, in part, central bank asset purchases”. Members’ judgment of the potential impacts of the term structure varied. While some expected that the abovementioned factors might “temper the reliability of the slope of the yield curve as an indicator of future economic activity”, several others doubted whether those factors were the cause of distortion of yield curve. After all, they believe continuing monitor is needed on the evolvement of the term structure.

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On the monetary policy outlook, the members generally agreed that it would be “appropriate to continue gradually raising the target range for the federal funds rate to a setting that was at or somewhat above their estimates of its longer-run level by 2019 or 2020”. On the forward guidance, some raised that “it might soon be “appropriate to modify the language in the post-meeting statement indicating that the stance of monetary policy remains accommodative”, as the Fed, though gradually, had raised the policy rates 7 times from December 2015 to June 2018, and there will be more increases going forward.