Fed still firmly on track for a March rate hike – Capital Economics

The minutes of the late January FOMC meeting show that officials were firmly on track to raise interest rates again in March, even before the latest incoming data showing stronger wage growth and core inflation or the boost to Federal spending, explains Paul Ashworth, Chief US Economist at Capital Economics.

Key Quotes

"A number of participants indicated that they had marked up their forecasts for economic growth", in part because those officials now think the impact of the recent tax cuts could be bigger than previously believed. Moreover, those comments pre-date the recent congressional agreement to boost both military and non-military discretionary spending, which means that the overall mix of fiscal stimulus will be significantly bigger over the next 18 months than was assumed at last month's FOMC meeting.”

"A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate." The upshot is that the addition of "further" in the accompanying policy statement was intended to convey a more hawkish stance.”

“We have long expected the Fed to hike interest rates four times this year, on the basis that Congress would loosen fiscal policy and core inflation would rebound markedly in 2018. That view is now rapidly gaining traction in the markets and among other economists. Fed officials themselves are still projecting three rate hikes, but were clearly more focused on the upside risks at this meeting.”

“Finally, the meeting also included a big presentation by the Fed staff on inflation models. The assessment of the Phillips curve was damning. The effects of output gaps on inflation were "not easy to discern empirically" and their strength "had diminished noticeably in recent years". Nevertheless, there was a possible sting in the tail since "some research" suggested that the relationship between the two could be non-linear, with the response of inflation increasing as utilisation rates rise to very high levels.”