Fed Looks for Answers on Missing Inflation in a Tight Labor Market

U.S. central bankers are looking for clues that underlying strength in the economy will underwrite their plans to raise interest rates for a third time this year, a record of their meeting last month showed, as officials wrestled with why inflation remains so low.


U.S. financing conditions remain easy, the economy is expected to grow above 2 percent for at least the next two years, and unemployment dropped to 4.2 percent last month, the lowest since 2001. For all that, inflation rose by a mere 1.4 percent in the year through August, and forecasters, including those at the Federal Reserve, expect it to remain subdued for a while. They aren’t sure why. The central bank has missed its 2 percent inflation target for most of the past five years.

“Many participants expressed concern that the low inflation readings this year might reflect not only transitory factors, but also the influence of developments that could prove more persistent,” according to minutes of the Sept. 19-20 meeting of the rate-setting Federal Open Market Committee. The minutes, released Wednesday in Washington, reeled off a list of potential explanations, ranging from the influence of technology on business pricing and pressure on health-care costs from government policies, to elusive “common global factors.”

U.S. central bankers next meet Oct. 31-Nov. 1 and again on Dec. 12-13. Investors have priced in a roughly 77 percent chance of another hike by the end of the year, according to trading in fed funds futures contracts, despite anxiety among Fed officials that something may be amiss in models they rely on to predict higher prices as the job market heats up.

“These minutes suggest that a majority of policy makers still need to have a hike this year disproven” by weaker economic data, said Michael Hanson, chief U.S. macro strategist at TD Securities in New York. But “they are willing to concede that the risk on inflation” remaining too low is higher than before.

Mix of Data

Several policy makers said their decision on whether to raise rates this year “would depend importantly on whether the economic data in coming months increased their confidence” on inflation rising toward target. The policy decision doesn’t hinge on inflation reports alone, but whether the mix of data continues to point to an economy that is pushing the edges of its capacity.

Data out since the meeting showed indicators of U.S. service sector and manufacturing activity rose in September to the highest in more than a decade, though that partly reflected slow supplier deliveries related to disruption after hurricanes battered Texas and Florida.

“They have less confidence in how inflation is behaving, but are much more comfortable that moderate growth is apt to persist,” said R.J. Gallo, a fixed-income investment manager at Federated Investors in Pittsburgh.

At the meeting, the U.S. central bank left the target range for the federal funds rate unchanged at 1 percent to 1.25 percent, while projecting another increase before the end of the year and announcing an October start for a gradual unwind of its $4.5 trillion balance sheet.

Clear Read

Getting a clear read on economic data may be difficult as some prices, such as gasoline, are affected by the hurricanes. The Fed’s post-meeting statement on Sept. 20 said the storms would affect the economy in the near term but were “unlikely to materially alter” its course over the medium term.

The minutes said Fed policy makers expected third-quarter growth “to be held down by the severe disruptions caused by the storms but to rebound beginning in the fourth quarter as rebuilding got under way and economic activity in the affected areas resumed.”

Even though the administration of President Donald Trump and Republicans in Congress say tax reform is a top priority, most Fed officials had either not assumed any fiscal stimulus in their projections made in September, the minutes said, “or had marked down the expected magnitude of any stimulus.”

Many officials said U.S. financial conditions would support the economic expansion, while a couple of policy makers “expressed concern that the persistence of highly accommodative financial conditions could, over time, pose risks to financial stability,” the minutes said.

The minutes said “many” participants “continued to believe” that labor-market pressures would eventually show through to higher inflation.

— With assistance by Christopher Condon


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