Make Way For Supply
Yesterday the Fed published the minutes of their January FOMC meeting and the message regarding the economy and labour markets continues to be one of strength. “Many participants” reported tight labour market conditions in their local districts with employers facing challenges in filling positions or retaining workers. Not only is the unemployment rate at 4.1% (close to a 20 year low) but also broader measures such as the U-6 (unemployed plus those employed part time for economic reasons and other adjustments) are at pre-crisis levels. Another point of interest is that despite wage inflation clearly rising, as evidenced by the latest 2.9% YoY data announced in early February, the Fed is still not yet overly worried with the minutes stating that FOMC participants “generally noted few signs of a broad-based pickup in wage growth in available data”.
Regarding growth, the FOMC mentioned incoming information is consistent with “continued above-trend economic growth”. Markets inferred this message as being slightly more hawkish than expected, resulting in the rates markets selling off and the curve steepening.
However, what really attracted our attention was the statement regarding the Fed’s mandate and potential changes to the way in which the inflation target is set. We wrote a blog about this earlier in the year and identified it as one that could have a material effect in the US Treasury curve (Be Aware of Policy Change at the Fed ). These minutes show that there are divided opinions among the FOMC members regarding the inflation target. Some participants support the current framework with a 2% fixed target, whereas “a couple of participants suggested that the Committee might consider expressing its objective as a range rather than a point estimate. A few other participants suggested that the FOMC could begin to examine whether adopting a monetary policy framework in which the Committee would strive to make up for past deviations of inflation from target might address the challenge of achieving and maintaining inflation expectations consistent with the Committee’s inflation objective, particularly in an environment in which the neutral rate of interest appeared likely to remain low.”
Some months ago, when we discussed our projections for rates in 2018, we did not expect a debate about the Fed’s mandate, except for maybe some conjecture in the press. If markets begin to price in a change in regime to one where inflation at say 2.5% is not an immediate concern for the Fed, we would expect the curve to steepen. In a rising inflation environment we would be more comfortable holding the shorter end of the Treasury curve as the Fed would not be expected to move rates higher at least for a while. In the same environment we would not be comfortable holding longer dated Treasuries as longer dated inflation expectations would most likely move higher. The formal discussions are clearly still at an early stage, but they remain something we will diligently follow with interest.