Fed minutes sound note of caution about June rate hike

The central bank is watching for evidence that a recent slowdown in the economy is temporary and that inflation is heating up toward its goal before committing to another interest rate hike, minutes from the Federal Reserve’s May 2-3 meeting showed.

The minutes, which were released Wednesday afternoon, gave a picture of a central bank that is divided on whether to raise rates as early as June, something that markets have generally been anticipating. Now investors will likely look to economic releases scheduled during the next three weeks, including the May jobs report, for clues as to whether the Fed will raise its primary interest rate when it next meets on June 13-14.

The minutes also contained details of how the Federal Reserve might begin to reduce the massive $4.5 trillion balance sheet it accumulated by purchasing Treasury and mortgage-backed securities during the recession in an effort to prop up the economy. Central bankers expressed preference for a plan that would let the assets gradually mature, but every three months reduce the amount the Fed reinvests in these purchases, leading to a predictable and orderly draw down.

The participants of the Fed’s Open Market Committee, which makes interest rate decisions, reiterated that it was important to gradually raise rates to a more normal level after holding them ultralow for years to help stimulate a struggling U.S. economy. Yet a few participants cautioned that the Fed could raise interest rates more gradually than previous forecasts had suggested, noting that the economy has showed a surprising weakness in recent months.

The Fed had forecast raising interest rates three times this year if the economy remained steady. The central bank lifted rates at its meeting in March, but then voted unanimously in May to leave its target interest rate unchanged at a range of 0.75 percent to 1 percent.

Ahead of the release of the minutes Wednesday afternoon, traders saw an 83 percent chance that the central bank would lift rates when it meets in June. Fed chair Janet L. Yellen will be holding a news conference at that meeting, which would allow her to more clearly explain the decision to the markets.

But some investors had been questioning whether the Fed would hold to that path, given more questionable figures on the economy that have emerged from government statistical bureaus.

One focus is inflation, which should gradually accelerate as the economy heats up. The central bank is charged with both restraining excess inflation and ensuring a healthy labor market. Yet the Fed’s favored gauge of inflation, which excludes food and energy, has been running persistently below its target, indicating the economy may have more room to grow before the central bank needs to raise rates.

“Overall, most participants viewed the recent softer inflation data as primarily reflecting transitory factors, but a few expressed concern that progress toward the Committee’s objective may have slowed,” the minutes of the closed-door meeting read.

While the job market has remained strong, growth in worker wages is surprisingly sluggish. And government data showed that the U.S. gross domestic product expanded at just 0.7 percent in the first three months of 2017, the slowest pace in three years. The Commerce Department will release a revised estimate for first-quarter growth on Friday morning.

The minutes also mentioned a recent slowdown in consumer spending, but said that this was likely temporary, due to factors such as an unusually mild winter that reduced energy bills.

In the minutes, the Federal Reserve mentioned several times that the recent slowdown in growth was likely to be “transitory” and that the economy would likely rebound in coming months.

Other indicators of the economy’s health remain strong. The unemployment rate is already below levels that central bankers expect to be normal in the long run, and businesses have been adding jobs at a steady clip. The minutes mentioned that some areas of the country were seeing “shortages of workers in selected occupations,” language that was not included in the minutes last month.

At its prior meeting in March, the Fed had laid out a plan to begin gradually reducing its $4.5 trillion balance sheet in late 2017 or early 2018 by simply allowing these assets to run off its balance sheet as they mature, and not reinvesting the proceeds in new securities. The Fed currently uses the principle from these bonds to buy new ones once they mature.

At its meeting in May, central bankers discussed a possible method for reducing this balance sheet. The committee would announce a set of gradually increasing limits on the dollar amounts of securities that would be allowed to run off each month, reinvesting only any amounts that exceeded those caps. The caps would initially be set at low levels and be raised every three months until they hit an unspecified target, the minutes said.

The policy would lead to a gradual and predictable reduction in the Fed’s balance sheet, and it would be easy to communicate to the public. “Nearly all policymakers expressed a favorable view of this general approach,” the minutes read.