Minutes of the Federal Open Market Committee
From June 13-14, 2017, Released on July 5
A joint meeting of the Federal Open Market Committee and the Board of Governors was held in the offices of the Board of Governors of the Federal Reserve System in Washington, D.C., on Tuesday, June 13, 2017, at 1:00 p.m. and continued on Wednesday, June 14, 2017, at 9:00 a.m.
Developments in Financial Markets and Open Market Operations
The manager of the System Open Market Account (SOMA) reported on developments in domestic and foreign financial markets over the period since the May FOMC meeting. Yields on Treasury securities and the foreign exchange value of the dollar had declined modestly, while equity prices had continued to rise, contributing to a further easing of financial conditions according to some measures. Moreover, realized and implied volatility in financial markets remained low. Meanwhile, inflation compensation edged lower. Survey results and market pricing suggested that market participants saw a high probability of an increase in the FOMC's target range for the federal funds rate at this meeting.
The deputy manager reviewed survey results on market expectations for SOMA reinvestment policy and for the evolution of the System's balance sheet over coming years. The deputy manager also commented on money market developments. Over the intermeeting period, the federal funds rate remained well within the FOMC's target range, and take-up at the System's overnight reverse repurchase agreement facility was little changed from the previous period. The spread between the three-month London interbank offered rate and the overnight index swap (OIS) rate had narrowed markedly in recent months after rising noticeably in advance of the implementation of money market fund reform in the fall of 2016. The deputy manager also summarized details of the operational approach that the Open Market Desk planned to follow if the Committee adopted the proposal for SOMA reinvestment policy to be considered at this meeting.
By unanimous vote, the Committee ratified the Desk's domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System's account during the intermeeting period.
System Open Market Account Reinvestment Policy
The Chair observed that, starting with the March 2017 FOMC meeting, Committee participants had been discussing approaches to reducing the Federal Reserve's securities holdings in a gradual and predictable manner. She noted that participants appeared to have reached a consensus on an approach that involved specifying caps on the monthly amount of principal payments from securities holdings that would not be reinvested; these caps would rise over the period of a year, after which they would remain constant. Given this consensus, the Chair proposed that participants approve the plan and that it be published as an addendum to the Committee's Policy Normalization Principles and Plans; the addendum would be released at the conclusion of this meeting so as to inform the public well in advance of implementing the reinvestment policy. It was anticipated that when the Committee determined that economic conditions warranted implementation of the program, that step would be communicated through the Committee's postmeeting statement. Participants unanimously supported the proposal.
POLICY NORMALIZATION PRINCIPLES AND PLANS
(Addendum adopted June 13, 2017)
All participants agreed to augment the Committee's Policy Normalization Principles and Plans by providing the following additional details regarding the approach the FOMC intends to use to reduce the Federal Reserve's holdings of Treasury and agency securities once normalization of the level of the federal funds rate is well under way.1
The Committee intends to gradually reduce the Federal Reserve's securities holdings by decreasing its reinvestment of the principal payments it receives from securities held in the System Open Market Account. Specifically, such payments will be reinvested only to the extent that they exceed gradually rising caps.
For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.
For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.
The Committee also anticipates that the caps will remain in place once they reach their respective maximums so that the Federal Reserve's securities holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively.
Gradually reducing the Federal Reserve's securities holdings will result in a declining supply of reserve balances. The Committee currently anticipates reducing the quantity of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system's demand for reserve balances and the Committee's decisions about how to implement monetary policy most efficiently and effectively in the future. The Committee expects to learn more about the underlying demand for reserves during the process of balance sheet normalization.
The Committee affirms that changing the target range for the federal funds rate is its primary means of adjusting the stance of monetary policy. However, the Committee would be prepared to resume reinvestment of principal payments received on securities held by the Federal Reserve if a material deterioration in the economic outlook were to warrant a sizable reduction in the Committee's target for the federal funds rate. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.
1. The Committee's Policy Normalization Principles and Plans were adopted on September 16, 2014, and are available at www.federalreserve.gov/monetarypolicy/files/FOMC_PolicyNormalization.pdf. On March 18, 2015, the Committee adopted an addendum to the Policy Normalization Principles and Plans, which is available at www.federalreserve.gov/monetarypolicy/files/FOMC_PolicyNormalization.20150318.pdf. Return to text
Staff Review of the Economic Situation
The information reviewed for the June 13-14 meeting showed that labor market conditions continued to strengthen in recent months and suggested that real gross domestic product (GDP) was expanding at a faster pace in the second quarter than in the first quarter. The 12-month change in overall consumer prices, as measured by the price index for personal consumption expenditures (PCE), slowed a bit further in April; total consumer price inflation and core inflation, which excludes consumer food and energy prices, were both running somewhat below 2 percent. Survey-based measures of longer-run inflation expectations were little changed on balance.
Total nonfarm payroll employment expanded further in April and May, and the average pace of job gains over the first five months of the year was solid. The unemployment rate moved down to 4.3 percent in May; the unemployment rates for African Americans and for Hispanics stepped down but remained above the unemployment rates for Asians and for whites. The overall labor force participation rate declined somewhat, and the share of workers employed part time for economic reasons decreased a little. The rate of private-sector job openings increased in March and April, while the quits rate was little changed and the hiring rate moved down. The four-week moving average of initial claims for unemployment insurance benefits remained at a very low level through early June. Measures of labor compensation continued to rise at moderate rates. Compensation per hour in the nonfarm business sector increased 2-1/4 percent over the four quarters ending in the first quarter, a bit slower than over the same period a year earlier. Average hourly earnings for all employees increased 2-1/2 percent over the 12 months ending in May, about the same as over the comparable period a year earlier.
Total industrial production rose considerably in April, reflecting gains in manufacturing, mining, and utilities output. Automakers' assembly schedules suggested that motor vehicle production would slow in subsequent months, but broader indicators of manufacturing production, such as the new orders indexes from national and regional manufacturing surveys, pointed to modest gains in factory output over the near term.
Real PCE rose solidly in April after increasing only modestly in the first quarter. Light motor vehicle sales picked up in April but then moved down somewhat in May. The components of the nominal retail sales data used by the Bureau of Economic Analysis to construct its estimate of PCE were flat in May, but estimated increases in these components of sales for the previous two months were revised up. In addition, recent readings on key factors that influence consumer spending pointed to further solid growth in total real PCE in the near term, including continued gains in employment, real disposable personal income, and households' net worth. Moreover, consumer sentiment, as measured by the University of Michigan Surveys of Consumers, remained upbeat in May.
Residential investment appeared to be slowing after increasing briskly in the first quarter. The first-quarter strength may have reflected housing activity shifting earlier in response to unseasonably warm weather last quarter, to an anticipation of higher future interest rates, or to both. Starts of new single-family homes edged up in April, but the issuance of building permits for these homes declined somewhat. Meanwhile, starts of multifamily units fell. Moreover, sales of both new and existing homes decreased in April.
Real private expenditures for business equipment and intellectual property seemed to be increasing further after rising at a solid pace in the first quarter. Both nominal shipments and new orders of nondefense capital goods excluding aircraft rose in April, and new orders continued to exceed shipments, pointing to further gains in shipments in the near term. In addition, indicators of business sentiment were upbeat in recent months. Although firms' nominal spending for nonresidential structures excluding drilling and mining declined in April, the number of oil and gas rigs in operation, an indicator of spending for structures in the drilling and mining sector, continued to rise through early June.
Nominal federal government spending data for April and May pointed to essentially flat real federal purchases in the second quarter. Real state and local government purchases appeared to be moving down, as state and local government payrolls declined, on net, in April and May, and nominal construction expenditures by these governments decreased in April.
The nominal U.S. international trade deficit widened slightly in March, with a small decline in exports and a small increase in imports. The March data, together with revised estimates for earlier months, indicated that real exports grew briskly in the first quarter and at a faster pace than in the second half of 2016. Real imports also increased in the first quarter but at a slower pace than in the second half of 2016. In April, the nominal trade deficit widened, as imports picked up while exports declined slightly. Net exports were estimated to have made a small positive contribution to real GDP growth in the first quarter. However, the April trade data suggested that net exports might be a slight drag on real GDP growth in the second quarter.
Total U.S. consumer prices, as measured by the PCE price index, increased 1-3/4 percent over the 12 months ending in April. Core PCE price inflation was 1-1/2 percent over those same 12 months. Over the 12 months ending in May, the consumer price index (CPI) rose a little less than 2 percent, while core CPI inflation was 1-3/4 percent. The median of inflation expectations over the next 5 to 10 years from the Michigan survey was unchanged in May, and the median expectation for PCE price inflation over the next 10 years from the Survey of Professional Forecasters also held steady in the second quarter. Likewise, the medians of longer-run inflation expectations from the Desk's Survey of Primary Dealers and Survey of Market Participants were essentially unchanged in June.
The economic expansions in Canada and the euro area as well as in China and many other emerging market economies (EMEs) continued to firm in the first quarter. In contrast, economic growth in the United Kingdom slowed sharply. Recent indicators suggested that real GDP growth in most foreign economies remained solid in the second quarter. Headline inflation across the advanced foreign economies (AFEs) generally appeared to moderate from the pace registered over the first quarter, as the effects of earlier increases in energy prices started to fade; core inflation continued to be subdued in many AFEs. Among the EMEs, inflation in China rose while inflation in Latin America fell. In Mexico, the effects of fuel price hikes in January and the pass-through from earlier currency depreciation to prices started to wane, but inflation remained above the central bank's target.
Staff Review of the Financial Situation
Domestic financial market conditions remained generally accommodative over the intermeeting period. U.S. equity prices increased over the period, longer-term Treasury yields declined, and the dollar depreciated. A decline in the perceived likelihood of a significant fiscal expansion and the below-expectations reading on the April CPI reportedly contributed to lower yields on longer-tenor Treasury securities. Market participants' perceptions of an improved global economic outlook appeared to provide some support to prices of risk assets.
FOMC communications over the intermeeting period were viewed as broadly in line with investors' expectations that the Committee would continue to remove policy accommodation at a gradual pace. Market participants interpreted the May FOMC statement and the meeting minutes as indicating that the Committee had not materially changed its economic outlook. In response to the discussion of SOMA reinvestment policy in the minutes, a number of market participants reportedly pulled forward their expectations for the most likely timing of a change to the Committee's reinvestment policy, a shift that was evident in the responses to the Desk's Survey of Primary Dealers and Survey of Market Participants. However, investors also reportedly viewed the Committee's planning as mitigating the risk that the process of reducing the size of the Federal Reserve's balance sheet would lead to outsized movements in interest rates or have adverse effects on market functioning.
The probability of an increase in the target range for the federal funds rate occurring at the June meeting, as implied by quotes on federal funds futures contracts, rose to a high level. However, the expected federal funds rate from late 2018 to the end of 2020 implied by OIS quotes declined slightly. Immediately following the May FOMC meeting, nominal Treasury yields rose at short and intermediate maturities, reportedly reflecting the response of investors to a passage in the postmeeting statement indicating the Committee's view that the slowing in real GDP growth during the first quarter was likely to be transitory. Later in the intermeeting period, yields declined in reaction to the release of weaker-than-expected April CPI data and the somewhat disappointing May employment report. On balance, the Treasury yield curve flattened, with short-term yields rising modestly and the 10-year yield declining. Both 5-year and 5-to-10-year-forward TIPS-based inflation compensation declined, in part reflecting the below-expectations inflation data.
Broad U.S. equity price indexes increased. One-month-ahead option-implied volatility on the S&P 500 index--the VIX--was little changed, on net, and remained near the lower end of its historical range.
Conditions in short-term funding markets were stable over the intermeeting period. Yields on a broad set of money market instruments remained in the ranges observed since the FOMC increased the target range for the federal funds rate in March. Term OIS rates rose as expectations firmed for an increase in the federal funds rate target at this meeting.
Financing conditions for nonfinancial businesses continued to be accommodative. Commercial and industrial loans outstanding increased in April and May after being weak in the first quarter, although the growth of these loans remained well below the pace seen a year ago. Issuance of both corporate debt and equity was strong. Gross issuance of institutional leveraged loans was solid in April and May, although it receded from the near-record levels seen over the previous two months.
Commercial real estate (CRE) loans on banks' books grew robustly in April and May, with nonfarm nonresidential loans leading the expansion. However, recent CRE loan growth was a bit slower than that during the first quarter, in part reflecting a slowdown in lending for both construction and multifamily units. Issuance of commercial mortgage-backed securities (CMBS) through the first five months of this year was similar to the issuance over the same period a year earlier. While delinquency rates on CRE loans held by banks edged down further in the first quarter, the delinquency rates on loans in CMBS pools continued to increase. The rise in CMBS delinquency rates was mostly confined to loans that were originated during the period of weak underwriting before the financial crisis. The increase in those delinquencies had generally been expected by market participants and was not anticipated to have a material effect on credit availability or market conditions.
Residential mortgage rates declined slightly, in line with yields on longer-term Treasury and mortgage-backed securities, but remained elevated relative to the third quarter of 2016. Despite the higher level of mortgage rates, growth in mortgage lending for home purchases remained near the upper end of its recent range during the first quarter. Delinquency rates on residential mortgage loans continued to edge down amid robust house price growth and still-tight lending standards for households with low credit scores and hard-to-document incomes.
Financing conditions in consumer credit markets remained generally accommodative, although some indicators pointed to modest reductions in credit availability in recent months. Tighter conditions for credit card borrowing were especially apparent within the subprime segment, where there had been some further deterioration of credit performance. On a year-over-year basis, overall credit card balances continued to grow in April at a robust rate, although the pace had moderated a bit from that of 2016.
Growth in auto loans remained solid through the first quarter. Overall delinquency rates on auto loans continued to be relatively low, but the delinquency rate among subprime borrowers remained elevated, reflecting easier lending standards in 2015 and 2016. Recent evidence suggested that these lending standards had tightened; the credit rating of the average borrower had trended higher, and new extensions of subprime auto loans had declined.
Over the period since the May FOMC meeting, foreign financial markets were influenced by incoming economic data and by political developments both abroad and in the United States. Most AFE and EME equity indexes edged higher, supported by robust first-quarter earnings reports and generally positive data releases overseas. The broad U.S. dollar depreciated about 1-3/4 percent over the intermeeting period, weakening against both AFE and EME currencies. In particular, the dollar depreciated against the Canadian dollar following communications by the Bank of Canada suggesting that the removal of policy accommodation could occur sooner than previously expected by market participants. The dollar also depreciated against the euro, which was supported by the results of the French presidential election and by stronger-than-expected macroeconomic releases. Those data releases prompted the European Central Bank at its June 8 meeting to change its assessment of risks to the economic outlook from "tilted to the downside" to "balanced." U.S. developments, including mixed economic data reports, also weighed on the dollar. In contrast, the dollar strengthened against sterling following the U.K. parliamentary election. Changes in longer-dated AFE sovereign bond yields were mixed, while shorter-dated yields moved slightly higher. EME sovereign spreads were little changed, while flows into EME mutual funds remained robust. However, Brazilian sovereign spreads widened and the Brazilian realdepreciated notably amid increased political uncertainty.
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