Stocks were little-changed on Wednesday as an early session sell-off was almost entirely erased after the release of the minutes from the Federal Reserve’s latest policy meeting.
Markets interpreted the minutes as having a slightly dovish tilt, with some traders hanging on the line which read, “It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”
This suggests an increase in inflation may not necessarily result in a more aggressive policy response from the Fed, thus allowing the economic cycle to last longer than some had previously expected.
On Thursday, politics should once again be top-of-mind for investors after The Wall Street Journal on Wednesday evening reported that President Donald Trump is weighing new tariffs on imported cars, citing national security concerns.
Early on Wednesday Trump had tweeted that “big news” would be forthcoming for U.S. automakers.
Now turning to the calendar for Thursday, on the economic data side, investors will get the weekly report on initial jobless claims, home prices for March, existing home sales in April, and the Kansas City Fed’s latest manufacturing activity reading.
And on the earnings front, Best Buy (BBY), Ross Stores (ROST), and The Gap (GPS) will be the notable reporters from the retail sector, while Hormel (HRL), AutoDesk (ADSK), and McKesson (MCK) will also report results on Thursday.
The Fed’s neutral rate fixation
On Wednesday, the Federal Reserve released the minutes from its policy meeting which concluded May 2 and resulted in the Fed leaving its benchmark interest rate target in a range of 1.5%-1.75%.
The easiest takeaway is the that the minutes had a dovish tilt because markets went up. Which is fine.
In this report from its latest meeting, the Fed also made clear that one of the core debates being had among members of the Federal Open Market Committee (FOMC) is the neutral rate of interest for the economy. This is the Fed Funds rate at which its dual objectives of price stability — defined as 2% inflation — and full employment are met.
Currently, the Fed’s forecasts suggest that around 3% is where this rate will fall over the long run.
During a discussion about the flattening yield curve, which drew a rash of headlines earlier this year as the spread between the 2-year and 10-year Treasury closed to the narrowest since 2007, some officials indicated this could be a result of investors seeing the long-run neutral as lower than current forecasts.
“Participants pointed to a number of factors contributing to the flattening of the yield curve, including the expected gradual rise of the federal funds rate, the downward pressure on term premiums from the Federal Reserve’s still-large balance sheet as well as asset purchase programs by other central banks, and a reduction in investors’ estimates of the longer-run neutral real interest rate,” the minutes read.
The flattening yield curve garnered outsized attention as an inverted yield curve — in which short-term rates exceed longer-term rates — has tended to happen just before the onset of a recession. Interestingly, some officials expressed skepticism that the economic signal to be taken from the yield curve is less potent than that data would suggest, a similar line of thinking to that put forth by Fed chair Jay Powell back in March.
“A few participants noted that such factors could make the slope of the yield curve a less reliable signal of future economic activity,” the minutes said. “However, several participants thought that it would be important to continue to monitor the slope of the yield curve, emphasizing the historical regularity that an inverted yield curve has indicated an increased risk of recession.”
And when it comes to the future of Fed communication, the prospect of the longer-run neutral rate actually settling below the current 3% target could change how the Fed discusses its upcoming policy actions.
In recent Fed statements, the central banks has characterized its overall stance towards policy as one in which the, “federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.” In other words, it’ll be a while before we get a Fed Funds rate that approaches 3%.
But what if the neutral rate is 2.5%? Or lower? In that case, we’re only about a year of interest rate hikes — assuming we continue on the path of one per quarter — from the Fed moving from accomodative to neutral, and then accelerating into a more restrictive policy stance.
Bring the neutral rate down, and some officials indicated in the minutes the language ought not to suggest that for “some time” rates will be below this longer-term target.
In June, the Fed will release an update of its forecast and we’ll see if the longer-run neutral rate expectation is lowered. But if there is no change in the Fed’s dot plot, we now have a sense of when to know that the Fed has lowered its forecast for the long-run neutral rate even if the dots don’t make it clear — it’ll be a matter of what they stop saying in their policy statements.
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland