MNI ANALYSIS: FOMC Minutes Show Members Aiming Above Neutral

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve minutes Wednesday strengthened the view

that the bank is firmly set on tightening, as a majority of policymakers

endorsed pushing the fed funds rate above existing estimates of the longer-run

neutral level.

     Members of the Federal Open Market Committee also indicated a continued

reluctance to estimate a precise level for neutral, known as r-star -- a

reticence which investors have interpreted as hawkish

     Nor was there any sign that the Fed is considering ending its balance sheet

normalization program any time soon, despite upward pressure on the fed funds

rate relative to the interest on reserves, the account of the September Federal

Open Market Committee meeting revealed.

     Minutes of the latest FOMC meeting revealed little disagreement over

near-term policy, noting that all participants thought it appropriate to

continue a "gradual approach to policy firming" by raising rates in September.

     There was also broad agreement over dispensing with the characterization of

monetary policy as "accommodative" before rates reached the range of estimates

of neutral, so as not to signal any change in policy, the minutes said.

     Waiting until later to clean up this bit of forward guidance might convey a

"false sense of precision" over the committee's estimates of the neutral rate,

the minutes said.

     Relying less on neutral as a guidepost for policy has been a recent refrain

among top Fed officials, as the minutes noted: "Estimates of the level of the

neutral federal funds rate would be only one among many factors that the

Committee would consider in making its policy decisions."

     --MODESTLY RESTRICTIVE

     According to median FOMC projections, the fed funds rate could cross into

modestly restrictive territory of above 3% by the end of 2019.

     "A number of policymakers judged that it would be necessary to temporarily

raise the federal funds rate above their assessments of its longer-run level in

order to reduce the risk of a sustained overshooting of the Committee's 2

percent inflation objective or the risk posed by significant financial

imbalances," the minutes said.

     A few others saw a need for above-neutral rates "for a time" while a couple

argued against restrictive policy in the absence of evidence that the economy

was overheating.

     --BALANCE SHEET

     The FOMC gave no indication it is considering cutting short the balance

sheet reduction program, despite some analysts suggesting that a scarcity of

bank reserves is pressuring the fed funds rate higher.

     The minutes noted that the spread between the fed funds rate and the

interest on reserves rate stood at just 3 basis points and seemed likely to

narrow to 2 basis points in the near future.

     However, "As yet, there were no signs that the upward pressure on the

federal funds rate relative to the IOER rate was due to scarcity of aggregate

reserves in the banking system."

     Some Fed officials have suggested the fed funds market may serve as a guide

to the appropriate terminal size of the balance sheet. If the Fed begins to hint

that the fed funds market is being influenced by reserves, investors might

quickly conclude that the balance sheet wind-down may have run its course.

     Importantly, the Fed also dropped no hint that it would make another

so-called technical adjustment to raise the IOER by 5 basis points less than the

fed funds target range to keep its benchmark rate contained. Markets are betting

on such an adjustment at the December meeting.

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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