Supply Chain Managers Should Track Jobs and Inflation Stats, Says Fed Committee

Supply chain managers may take some comfort in the recent statement by The Federal Reserve policymakers regarding a labor-market recovery. According to IHS Global Insight economists, confirmed confidence in a rebound was made at the end of QE3.

“The Fed also reconfirmed their expectation that the downside risks to inflation have abated since the start of the year even though inflation has slowed and inflation expectations deteriorated recently,” noted Paul Edelstein, IHS director of Financial Economics.

The committee kept its pledge to keep interest rates low for a “considerable time” but added language suggesting that the timing and pace of rate hikes could be faster or slower than expected depending on what happens with jobs and inflation.

Here are some key highlights from the minutes:

*There are cracks in the Fed’s view on inflation. A “few” policymakers were concerned that low inflation will persist for quite some time. At the meeting, the committee claimed that even though market-based inflation expectations (TIPS spreads) deteriorated, survey-based expectations, such as those in the Reuters/University of Michigan Consumer Sentiment Index, were well anchored. The problem is that those expectations typically over-predict the rate of inflation and are closely linked to gasoline prices. Indeed, they have declined recently. Several explanations were offered for the decline in TIPS spreads, other than inflation expectations, including a drop in the inflation risk premium and liquidity issues in the TIPS market. However, one participant noted that this could reflect investor concerns about low inflation accompanied by weak economic growth, which is something the Fed would want to take into account. The link between inflation and economic growth in Fed deliberations is a new and significant development because it suggests a waning tolerance for below-target inflation within the committee. What’s less clear is if rate hikes would be delayed if inflation remains below 2%.

*The Fed is keeping an eye on overseas developments. Downside growth risks in Europe, China, and Japan, along with the strengthening US dollar, were discussed as risks to the US outlook over the medium term. The implication is that the Fed might have to delay rate hikes next year if global growth falters. However, “many” participants viewed the potential fallout on the US economy as limited due to the small share of external trade in GDP and shifts in the structure of US trade and production over time. Falling oil prices were cited as a countervailing factor. Thus for now, it doesn’t seem that global growth risks will be a major factor in the Fed’s interest rate decisions. In fact, language about foreign economic developments was intentionally left out of the policy statement.

*The pace of rate hikes, independent from the timing, is now an issue. With policy set to normalize next year, a number of participants proposed clarifying the Fed’s approach. No new language was added to the policy statement, but the language indicating that economic conditions could warrant the Fed keeping the fed funds rate below longer-run values even after inflation and unemployment are near mandate-consistent levels, was retained. In previous tightening cycles, the Fed would hike 1-quarter point per meeting and the committee’s interest rate projections basically reflect this approach. However, we think the Fed will move more slowly at first; 1-quarter point at every other meeting for the first year. We also think that, if the Fed does decide on a slower pace, it will have to signal as much in its forward guidance since an unexpected pause in rate hikes would probably be an unintentional and bearish signal to markets.

“Nothing in the minutes from the October Fed meeting changes our mind that the committee will raise interest rates around the middle of next year,” said Edelstein. “Certainly, overseas growth concerns won’t deter them.”

He added that there is some “angst” over inflation and inflation expectations, but the Fed discounts these concerns.

“As long as inflation remains at or above its current 1.5%, we don’t expect the Fed to alter its plans. Another decline in inflation towards 1%, however, would embolden those Fed members who are concerned about the drop in TIPS spreads. Otherwise, the Fed’s (justified) satisfaction with the labor market, its improvement and its tightening, will carry the day.”

SC
MR