April 2014 FOMC Meeting Minutes: Housing Sector May Pose Downside Risks

Econintersect: The 30 April 2014 meeting statement presented the actions taken. This post covers the economic discussion during this FOMC meeting between the members. The Fed’s Balance Sheet (which we report on weekly) continues to grow at record levels (albeit now at a slower pace).

This was the second meeting chaired by Janet Yellen. The meeting minutes have a slightly different feel with more convergence of views and events. The more interesting points are highlighted in bold below.

One of the more interesting meeting minute statements:

… a number of participants pointed to possible sources of downside risk to growth, including a persistent slowdown in the housing sector or potential international developments, such as a further slowing of growth in China or an increase in geopolitical tensions regarding Russia and Ukraine.

Econintersect publishes below the views of the FOMC members, and ignores the reports given to the members. We are looking for a glimpse of insight into the minds of the FOMC members.

Participants’ Views on Current Conditions and the Economic Outlook

In their discussion of the economic situation and the outlook, meeting participants generally indicated that their assessment of the economic outlook had not changed materially since the March meeting. Severe winter weather had contributed to a sharp slowing in activity during the first quarter, but recent indicators pointed to a rebound and suggested that the economy had returned to a trajectory of moderate growth. However, some participants remarked that it was too early to confirm that the bounceback in economic activity would put the economy on a path of sustained above-trend economic growth. In general, participants continued to view the risks to the outlook for the economy and the labor market as nearly balanced. However, a number of participants pointed to possible sources of downside risk to growth, including a persistent slowdown in the housing sector or potential international developments, such as a further slowing of growth in China or an increase in geopolitical tensions regarding Russia and Ukraine.

Participants noted that business contacts in many parts of the country were generally optimistic about economic prospects, with reports of increased sales of automobiles, higher production in the aerospace industry, and increased usage of industrial power; in addition, a couple of firms with a global presence reported a notable increase in demand from customers in Europe. Contacts in several Districts pointed to plans for increasing capital expenditures or to stronger demand for commercial and industrial loans. In the agricultural sector, the planting season was under way, but there were concerns about the effects of drought on production in some areas.

Most participants commented on the continuing weakness in housing activity. They saw a range of factors affecting the housing market, including higher home prices, construction bottlenecks stemming from a scarcity of labor and harsh winter weather, input cost pressures, or a shortage in the supply of available lots. Views varied regarding the outlook for the multifamily sector, with the large increase in multifamily units coming to market potentially putting downward pressure on prices and rents, but the demand for this type of housing expected to rise as the population ages. A couple of participants noted that mortgage credit availability remained constrained and lending standards were tight compared with historical norms, especially for purchase mortgages. However, reports from some Districts indicated that real estate and housing-related business activity had strengthened recently, consistent with the solid gains in consumer spending registered in March.

Conditions in the labor market continued to improve over the intermeeting period and participants generally expected further gradual improvement. Participants discussed a range of research and analysis bearing on the amount of available slack remaining in the labor market. A number of them argued that several indicators of labor underutilization–including the low labor force participation rate and the still-elevated rates of longer-duration unemployment and of workers employed part time for economic reasons–suggested that there is more slack in the labor market than is captured by the unemployment rate alone. Low nominal wage inflation was also viewed as consistent with slack in labor markets. However, some participants reported that labor markets were tight in their Districts or that contacts indicated some sectors or occupations were experiencing shortages of workers. Another participant observed that labor underutilization, as measured by an index that takes employment transition rates into account, was consistent with past periods in which the official unemployment rate had reached its current level, and had declined about as much relative to the official unemployment rate as it had in previous economic recoveries.

In discussing the effect of labor market conditions on inflation, a number of participants expressed skepticism about recent studies suggesting that long-term unemployment provides less downward pressure on wage and price inflation than short-term unemployment does. A couple of participants cited other research findings that both short- and long-term unemployment rates exert pressure on wages, with the effects of long-term unemployment increasing as the level of short-term unemployment declines. Moreover, a few participants pointed out that because of downward nominal wage rigidity during the recession, wage increases are likely to remain relatively modest for some time during the recovery, even as the labor market strengthens. It was also noted that because inflation was expected to remain well below the Committee’s 2 percent objective and the unemployment rate was still above participants’ estimates of its longer-run normal level, the Committee did not, at present, face a tradeoff between its employment and inflation objectives, and an expansion of aggregate demand would result in further progress relative to both objectives.

Inflation continued to run below the Committee’s 2 percent longer-run objective over the intermeeting period. Many participants saw the recent behavior of the prices of food, energy, shelter, and imports as consistent with a stabilization in inflation and judged that the transitory factors that had reduced inflation, such as declines in administered prices for medical services, were fading. Most participants expected inflation to return to 2 percent within the next few years, supported by highly accommodative monetary policy, stable inflation expectations, and a continued gradual recovery in economic activity. However, a few others expressed the concern that the return to 2 percent inflation could be even more gradual.

In their discussion of financial stability, participants generally did not see imbalances that posed significant near-term risks to the financial system and the broader economy, but they nevertheless reviewed some financial developments that pointed to potential future risks. A couple of participants noted that conditions in the leveraged loan market had become stretched, although equity cushions on new deals remained above levels seen prior to the financial crisis. Two others saw declining credit spreads, particularly on speculative-grade corporate bonds, as consistent with an increase in investors’ appetite for risk. In addition, several participants noted that the low level of expected volatility implied by some financial market prices might also signal an increase in risk appetite. Some stated that it would be helpful to continue to explore the appropriate regulatory, supervisory, and monetary policy responses to potential risks to financial stability.

It was noted that the changes to the Committee’s forward guidance at the March FOMC meeting had been well understood by investors. However, a number of participants emphasized the importance of communicating still more clearly about the Committee’s policy intentions as the time of the first increase in the federal funds rate moves closer. Some thought it would be helpful to clarify the reasoning underlying the language in the FOMC’s postmeeting statement indicating that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. In addition, a few participants judged that additional clarity about the Committee’s reaction function could be particularly important in the event that future economic conditions necessitate a more rapid rise in the target federal funds rate than the Committee currently anticipates. A number of participants suggested that it would be useful to provide additional information regarding how long the Committee would continue its policy of rolling over maturing Treasury securities at auction and reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities.

Steven Hansen

Source: Federal Reserve