Participants' Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation and the outlook, meeting participants saw the information received over the intermeeting period as suggesting that labor market conditions had improved further in late 2015 even as economic growth slowed. Household and business spending had been increasing at moderate rates; however, net exports had been soft and inventory investment had slowed. A range of labor market indicators pointed to some additional decline in underutilization of labor resources. Inflation continued to run below the Committee's 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation declined further over the intermeeting period; survey-based measures of longer-term inflation expectations were little changed, on balance, in recent months.
In considering the outlook for economic activity, participants weighed the divergent signals from recent strength in the labor market and the modest increase in real GDP suggested by the available data on spending and production. In part, the projected slow growth of real GDP in the fourth quarter of 2015 appeared to be caused by reduced inventory investment and a weather-related slowing in consumer spending on energy services--developments that would likely be reversed in the current quarter. Moreover, some participants noted that the preliminary spending data and initial estimates of GDP are often revised substantially, and they judged that labor market indicators tended to provide a more reliable early reading on the economy's underlying strength.
In assessing the medium-term outlook, participants discussed the extent to which the recent turbulence in global financial markets might restrain U.S. economic activity. While acknowledging the possible adverse effects of the tightening of financial conditions that had occurred, most policymakers thought that the extent to which tighter conditions would persist and what that might imply for the outlook were unclear, and they therefore judged that it was premature to alter appreciably their assessment of the medium-term economic outlook. They continued to anticipate that economic activity would expand at a moderate pace over the medium term and that the labor market would continue to strengthen. Inflation was expected to remain low in the near term, in part because of the further decline in energy prices. However, most participants continued to anticipate that inflation would rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipated and the labor market strengthened further. Given their increased uncertainty about how global economic and financial developments might evolve, participants emphasized the importance of closely monitoring these developments and of assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.
Growth of consumer spending appeared to have slowed in the fourth quarter, with the December data showing a decline in nominal retail sales and a step-down in purchases of new motor vehicles from the elevated level of the preceding three months. Moreover, households' spending on energy services was evidently held down by unseasonably warm weather in many parts of the country. Although participants received mixed reports from their District contacts on consumer spending, some heard that retail activity had been generally positive at year-end, and a number of participants relayed indications that spending on services in their Districts remained solid. Regarding the outlook for consumer spending, a number of participants noted that the recent moderation in spending seemed inconsistent with continued strong gains in households' real income from rising employment and falling energy prices and with the relatively elevated level of consumer sentiment. Because of these favorable fundamentals, many participants indicated that they still expected consumer spending to contribute importantly to economic growth in the coming year. However, several were concerned that the rise in the saving rate since the middle of 2015 might suggest an elevated degree of caution about the economic outlook or that the recent retreat in equity values, if sustained, might damp spending. Nonetheless, a couple of others pointed out that information from surveys of consumer sentiment suggested that households, to date, had not appeared to be particularly sensitive to changes in financial market conditions.
Housing sales and construction continued to trend up though the end of 2015, extending the gradual recovery in the housing sector. In participants' reports on economic conditions in their Districts, some highlighted the sector as one in which activity had improved or about which contacts were upbeat. A couple of participants noted that new mortgage lending regulations appeared to have slowed the mortgage origination process and temporarily reduced home sales.
Manufacturing activity continued to weaken in late 2015. Production continued to contract in industries--such as steel and heavy machinery--in which demand had been negatively affected, either directly or indirectly, by the appreciation of the dollar, slow economic growth abroad, and declining oil prices. Participants from those Reserve Banks that conduct surveys of manufacturing activity reported that the weakness extended into January. Nonetheless, several participants pointed to aerospace, autos, and consumer products as areas of strength in the manufacturing sector, and a few commented that manufacturers surveyed in their Districts were still relatively optimistic about the outlook for 2016. Information on business activity outside of the manufacturing sector was mixed. Commercial construction was reported to be strong in a couple of Districts, and a few participants commented that government spending was likely to provide a boost to business activity in the coming year. Several participants reported moderate growth in services industries, but a couple noted some slowing of activity. Some participants reported a deterioration in business sentiment among their contacts in the wake of recent global economic and financial developments, which could result in more-cautious capital spending plans.
Downward pressure on domestic energy activity intensified over the intermeeting period as oil prices dropped further. The imbalance of the supply of crude oil relative to demand remained very high and appeared unlikely to be resolved quickly, as was evidenced by a further downshift in oil futures prices. Participants' contacts in the energy sector reported that firms were still adjusting to lower prices and the contraction in their businesses, and some firms expected that they would need to cut investment and employment further. In addition, it was noted that energy firms continued to face tightening financial conditions and that financial stress was building for those with high levels of debt. In agriculture, depressed levels of crop prices and weak global demand continued to weaken farm income.
A broad range of indicators showed ongoing improvement in labor market conditions. Most notably, increases in nonfarm payroll employment were quite strong during the final three months of 2015. Although the unemployment rate, at 5.0 percent, was unchanged over that period, it was at a level close to or below most participants' estimates of its longer-run normal rate. Moreover, the labor force participation rate and the employment-to-population rate moved up toward year-end. Many viewed labor market underutilization as having been substantially reduced over the past year, and a few saw slack as having been largely eliminated. In their comments on labor market conditions, participants cited strong employment gains, low levels of unemployment in their Districts, reports of shortages of workers in various industries, or firming in wage increases. Most anticipated that employment would expand at a solid rate over the year ahead, although several saw the prospect of some moderation in employment gains from the particularly large increases in the fourth quarter of 2015.
Participants discussed the implications of the further decline in the prices of oil and other commodities and the additional appreciation of the dollar since the previous FOMC meeting for the outlook for inflation. They agreed that these developments would keep inflation low in the near term but offered a range of views on the effects on the medium-term outlook and the risks attending the outlook. Most continued to anticipate that once the price of energy and the exchange value of the dollar stabilized, the effects of those factors on inflation would fade. Several saw that outlook as depending importantly on continued strengthening of the labor market or on an above-trend pace of economic activity. Moreover, some emphasized the need for longer-run inflation expectations to remain well anchored. In that regard, while some participants interpreted the recent readings on survey-based measures of inflation expectations and market-based measures of inflation compensation as suggesting that long-term inflation expectations were still relatively well anchored, some others expressed concern about the further decline in inflation compensation recently and the historically low levels of some survey measures of longer-run inflation expectations. Some noted the difficulty of distinguishing declines in expected inflation embedded in those market-based measures from changes in risk and liquidity premiums or of interpreting the current high correlation of far-forward measures of inflation compensation and oil prices. Although most participants continued to expect that inflation would rise to the Committee's 2 percent objective over the medium term, a number of participants indicated that, in light of recent developments, they viewed the outlook for inflation as somewhat more uncertain or saw the risks as being to the downside. Several participants reiterated the importance of monitoring inflation developments closely to confirm that inflation was evolving along the path anticipated by the Committee.
Regarding the foreign economic outlook, it was noted that the slowdown in China's industrial sector and the decline in global commodity prices could restrain economic activity in the EMEs and other commodity-producing countries for some time. Participants discussed recent developments in China, including the possibility that structural changes and financial imbalances in the Chinese economy might lead to a sharper deceleration in economic growth in that country than was generally anticipated. Such a downshift, if it occurred, could increase the economic and financial stresses on other EMEs and on commodity producers, including Canada and Mexico. Moreover, global financial markets could continue to be affected by uncertainty about China's exchange rate regime. While the exposure of the United States to the Chinese economy through direct trade ties was limited, a number of participants were concerned about the potential drag on the U.S. economy from the broader effects of a greater-than-expected slowdown in China and other EMEs.
Participants also discussed a range of issues related to financial market developments. Almost all participants cited a number of recent events as indicative of tighter financial conditions in the United States; these events included declines in equity prices, a widening in credit spreads, a further rise in the exchange value of the dollar, and an increase in financial market volatility. Some participants also pointed to significantly tighter financing conditions for speculative-grade firms and small businesses, and to reports of tighter standards at banks for C&I and CRE loans. The effects of these financial developments, if they were to persist, may be roughly equivalent to those from further firming in monetary policy. Participants mentioned several apparent factors underlying the recent financial market turbulence, including economic and financial developments in China and other foreign countries, spillovers in financial markets from stresses at firms and in countries that are producers of energy and other commodities, and an increase in concerns among market participants regarding the prospects for domestic economic growth. However, a number of participants noted that the large magnitude of changes in domestic financial market conditions was difficult to reconcile with incoming information on U.S. economic developments. A couple of participants pointed out that the recent decline in equity prices could be viewed as bringing equity valuations more in line with historical norms. Additionally, a few participants cautioned that valuations in CRE markets should be closely monitored. The effects of a relatively flat yield curve and low interest rates in reducing banks' net interest margins were also noted.
Participants discussed whether their current assessments of economic conditions and the medium-term outlook warranted either increasing the target range for the federal funds rate at this meeting or altering their earlier views of the appropriate path for the target range for the federal funds rate. Participants agreed that incoming indicators regarding labor market developments had been encouraging, but also that data releases since the December meeting on spending and production had been disappointing. Furthermore, developments in commodity and financial markets as well as the possibility of a significant weakening of some foreign economies had the potential to further restrain domestic economic activity, partly because the large cumulative declines in energy and other commodity prices could have pronounced adverse effects on some firms and countries that are important producers of such commodities. However, a few noted that the potential positive effects of lower energy costs on economic activity were a mitigating factor. Participants judged that the overall implication of these developments for the outlook for domestic economic activity was unclear, but they agreed that uncertainty had increased, and many saw these developments as increasing the downside risks to the outlook.
As expected, inflation had continued to run below 2 percent, but the further decline in energy prices and the additional appreciation of the dollar likely implied that inflation would take somewhat longer than previously anticipated to rise to the Committee's objective. It was noted that although it was generally appropriate for monetary policy not to respond substantially to temporary shocks to inflation, that prescription depended in part on the assumption that longer-term inflation expectations remained well anchored. Participants pointed out that some market-based measures of longer-term inflation compensation had declined to historically low levels, which increased concerns about whether inflation expectations could be moving lower. Other participants, however, noted that survey-based measures of longer-term inflation expectations had remained fairly steady, and a few participants characterized measures of underlying inflation rates, such as core and trimmed mean PCE inflation, as having stayed relatively stable. Most participants still expected inflation to increase gradually once energy prices and the prices of non-energy imports stabilized and as the labor market strengthened further. However, a few participants noted that direct evidence that inflation was rising toward 2 percent would be an important element of their assessment of the outlook and of the appropriate path for policy.
Participants expressed a range of views regarding the balance of risks to the medium-term economic outlook and its implications for the conduct of monetary policy. Most participants indicated that it was difficult to judge at this point whether the outlook for inflation and economic growth had changed materially, but they thought that uncertainty surrounding the outlook had increased as a result of recent financial and economic developments. Most participants were of the view that there was not yet enough evidence to indicate whether the balance of risks to the medium-term outlook had changed materially, but others judged that recent developments had increased the level of downside risks or that the risks were no longer balanced.
Several participants noted that monetary policy was less well positioned to respond effectively to shocks that reduce inflation or real activity than to upside shocks, and that waiting for additional information regarding the underlying strength of economic activity and prospects for inflation before taking the next step to reduce policy accommodation would be prudent. While participants continued to expect that gradual adjustments in the stance of monetary policy would be appropriate, they emphasized that the timing and pace of adjustments will depend on future economic and financial market developments and their implications for the medium-term economic outlook. A couple of participants questioned whether some financial market participants fully appreciated that monetary policy is data dependent, and a number of participants emphasized the importance of continuing to communicate this aspect of monetary policy.