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Elliot Clarke, Research Analyst at Westpac, explains that the May FOMC minutes provide a clear assessment of the risks that the US currently faces, particularly with respect to inflation; financial conditions and foreign trade.

Key Quotes

“The conclusion to draw is that an acceleration in the pace of interest rate hikes is not currently justified, nor is it expected.”

“The market has recently been concerned that inflation may be getting away from the FOMC (given annual CPI inflation at 2.5%yr and persistent strength in the oil price), the Committee is unperturbed.”

“To see upside inflation risks build, a stronger wage inflation pulse is necessary. At present the employment cost index is only reporting “a gradual pickup in wage increases”, and the signal from other wage measures is “less clear”. Two other important considerations for the pass through of wages to activity and thus inflation is that real hourly earnings growth is currently flat and the savings rate near historic lows. The capacity of households to boost consumption and thus inflation is therefore very limited.”

“Turning to financial conditions, as yet there is no concern of them becoming an impediment to growth or policy. The 10yr yield has moved back to the highs of 2013, but the US dollar has only partly retraced its 2017 depreciation. Further, asset markets remain near recent highs.”

“Equally significant however is the reference to being nearer neutral and a clear desire to keep the yield curve’s positive slope.”

“We do not believe that the yield curve will invert in this instance, in part because higher deficits should see the term premium rise. However, the curve will remain comparatively flat versus history, restricting both the timing and the scale of further rate hikes. This is a key justification for both the market’s and our own view of only two further hikes in 2018 and two more in 2019 – a stark contrast to the FOMC’s seven hikes to end-2020.”

“A final point on economic policy. While the GDP forecasts of the Committee were buoyed by Congress’ spending and tax policies coming into 2018, it is clear from the minutes that members still see a great deal of uncertainty over the timing and scale of this stimulus. Adding further uncertainty are lingering trade tensions between the US and China. Both of these factors further justify a conservative approach to monetary policy over the coming 18 months.”