June FOMC Minutes Highlight Just How Uncertain the FOMC Is
- The Fed continues to expect that it will eventually be able to ease rates later this year but it needs to feel confident that the medium-term inflation outlook is remaining well behaved.
- Amid the hope and baseline expectation that tariffs are a one-off shock there is growing uncertainty about the persistence of the tariffs’ shock on inflation and the persistence of tariffs themselves as a regular ongoing part of the policy process.
- June’s employment report will have been a positive surprise but not a large enough one to really shift expectations on its own.
- One subtle impact of all the uncertainty and short-term noise in the data is that while forecast opinions should be weakly held, the data may not be particularly informative in helping update them for some time yet. This applies to the labor market’s dovish pull as much as inflation’s hawkish push higher.
As Powell made sure to emphasize during his recent testimony to Congress, “most participants” thought that at least some additional easing “would likely be appropriate, noting that upward pressure on inflation from tariffs may be temporary or modest, that medium- and longer-term inflation expectations had remained well anchored, or that some weakening of economic activity and labor market conditions could occur.” The more hawkish contingent which does not expect any further cuts this year pointed to elevated inflation, upside risks to inflation, and the possibility that the economy may remain surprisingly resilient. Waller and Bowman’s post-meeting comments which temporarily opened up the possibility of a July cut were voiced during the meeting as well but noted largely just as “in line with their expectations” without too much detail.
The labor market is expected to see a” gradual softening of conditions” by many participants. This balances the weakening of labor supply due to slowing immigration, noted by “several,” while “most participants suggested that higher tariffs or heightened policy uncertainty would weigh on labor demand.” This softening expectation of the baseline naturally carries larger risks and “a few participants saw risks to the labor market as having become predominant” suggesting that the baseline is seen as quite tenuous and needing support. The absence of a move higher in initial claims since the meeting and surprisingly robust slack data recently (May JOLTS and June household survey) will likely lead to only most updating of these views given the noise in the data and sluggish updating of priors amid so much uncertainty about the underlying state of the economy and policy effect sizes and timing.
Unsurprisingly, the Committee’s discussion of the inflationary impact of tariffs remains highly uncertain. “There was considerable uncertainty, however, about the timing, size, and duration of” the inflationary impacts of tariffs. It does seem that as time has gone on over the post-election period and the tariffs have seemed more like a persistent feature of the policy day-to-day rather than a short- burst of activity, the Fed is becoming ever more cautious about seeing them as a peaked clearly one-off event rather than a series of modestly inflationary shocks; that isn’t universally held and Waller and Bowman at least are both clearly in the one-off camp. The subsequent discussion highlights just how many different approaches firms may take given amid the uncertainty around the policies themselves and then the downstream effects when setting prices. These elements include:
- “Many participants noted that the eventual effect of tariffs on inflation could be more limited if trade deals are reached soon, if firms are able to quickly adjust their supply chains, or if firms can use other margins of adjustment to reduce their exposure to the effects of tariffs.”
- “Firms not directly subject to tariffs might take the opportunity to increase their prices if other prices rise, particularly those of complementary products.”
- But there are reasons to think that the pass-throughs may not be as large as back-of-the-envelope math (or more sophisticated analyses) suggest, “several participants observed that the pass-through of tariffs might be limited if households and businesses exhibit a low tolerance for price hikes or if firms seek to increase their market share as others raise their prices. A few participants noted that the pass-through of tariff-related costs likely would be greater for smaller businesses or businesses with narrow profit margins.”
The emphasis on medium-term inflation concerns in the reaction function, rather than confidence tariffs will be a one-off, and the better-than-expected labor market data over the past few weeks could set the Fed up for a joint hawkish lurch if sustained. The issue here is that a less slack labor market has a direct impact reducing its direct dovish impulse and also likely implying more medium-term persistence of tariff’s inflationary shock. Better than expected labor market outcomes also suggest a higher neutral rate the current longer-run dot; something obliquely hinted at by Powell in recent appearances.
With Powell stating that changes to the Fed’s longer-run statement on policy strategy due later this summer, almost surely debuting at Jackson Hole, the Minutes contained some discussion of how the FOMC could better communicate and make policy around the inherent risks and uncertainties with the macroeconomic environment. Having escaped the zero lower bound and moved into a new post-covid policy and economic environment, the Fed is trying to develop a policy framework which is more robust to less obviously well anchored inflation expectations and broader structural and cyclical uncertainty. This is a negative version of the scenarios which confronted the Fed in the late-90s and early 2000s and from which there is a lot of quality analytic work to be digested.
