The Federal Reserve recently released the minutes of the Federal Open Market Committee’s June meeting, and this is a rundown of its concerns and projections for the economy in the coming months. While revised projections of economic indicators were released in June, the rationale behind these revisions can be gleaned from the minutes of the meeting.
1. Economic growth will rebound in the second quarter
Based on the analysis of the FOMC, real growth in gross domestic product, the biggest measure of economic growth, is expected to bounce back in the second quarter as consumer spending improves, exports rise, and inventory investment picks up. The group lowered its assumed pace of potential economic growth for 2014 to a range of 2.1-2.3 percent from 2.8-3 percent in its March projections because of recent downward surprises in the unemployment rate and weaker-than-expected real GDP.
The economy contracted 2.9 percent in the first quarter, owing in part to a long, unproductive winter and sluggish demand. A faster pace of economic expansion may be supported by diminishing drag on spending from changes in fiscal policy, increases in consumer and business confidence, further improvements in credit availability, gains in household net worth, rising employment and wages, and a pickup in the rate of foreign economic growth, according to the minutes.
2. Views about labor conditions are still split
Participants of the FOMC meeting had diverse views about the underlying strength of the labor market. Some believed that slack in the labor market remained elevated, while others thought it was greater than measured by the official unemployment rate, citing the still-high level of workers employed part time for economic reasons or the depressed labor force participation rate.
The labor force participation rate remains low, at 62.8 percent, having shrunk from 63.2 percent last year. The FOMC projections suggest that the unemployment rate will be in the range of 6-6.1 percent this year, revised downward from an estimated range of 6.1-6.3 percent this March.
“A couple of participants anticipated that the decline in unemployment would be damped as part-time workers shift to full-time jobs and as nonparticipants rejoin the labor force, while a few others commented that they expected no lasting reversal of the decline in labor force participation,” the minutes of the meeting read, reflecting the pessimism about the recovery of the labor market among participants.
However, real-time data show that the recovery in the labor market is stronger than was earlier anticipated. The unemployment rate in June fell to 6.1 percent from 6.3 percent as the economy added 288,000 jobs. Initial claims for unemployment benefits were down 11,000 to a seasonally adjusted 304,000 in the week ended July 5, according to Bureau of Labor Statistics data. Job openings in May were up to 4.6 million from 4.5 million in April, BLS data showed.
3. Softness in prices will remain well into next year
The FOMC projects inflation — measured by personal consumption expenditures — to be in a range between 1.5 and 1.7 percent in 2014, lower than the Fed’s target of 2 percent. Inflation may remain anchored due to subdued commodity and import prices this year, as well as persistent slack in labor and product markets. But some participants believed consumer spending could pick up from increases in income thanks to the improving labor market.
“Some participants expressed concern about the persistence of below-trend inflation, and a couple of them suggested that the Committee may need to allow the unemployment rate to move below its longer-run normal level for a time in order keep inflation expectations anchored and return inflation to its 2 percent target,” according to the FOMC minutes.
4. The committee is divided about communication
FOMC participants were greatly divided on how to guide the markets in the timing of the shift in monetary policy. A good number of participants were of the belief that “a more gradual approach might be appropriate if forecasts of above-trend economic growth later this year were not realized.” A few (the minority) suggested that the committee needs to continue on its path of accommodation until inflation returns to its target in the medium term to keep inflationary expectations alive and kicking. And yet, there were some who feared economic growth over the medium run might be faster than currently expected.
There was a general consensus on the timing for the final reduction in the large scale asset purchase (LSAP) program of the Fed to be around October, assuming there are no economic shocks before then.
“It was observed that it would be useful for the Committee to develop and communicate its plans to the public later this year, well before the first steps in normalizing policy become appropriate,” the minutes said, giving a timeline for the first increase in federal funds rate. Most of the members agreed that the Fed should only end the reinvestments of the bonds it bought back under LSAP after the first increase in federal funds rate.
5. Housing markets remain vulnerable
FOMC members expressed concerns about softness in the housing sector, and in particular about the still-soft indicators of residential construction. According to the latest data published by U.S Census Bureau, privately owned housing starts in May were 6.5 percent lower, at 1 million, from April. Single-family housing starts in May were at a rate of 625,000, 5.9 percent below the revised April figure of 664,000.
The reason for this weakness, according to FOMC members, was due to restrictive credit conditions, particularly for households with low credit scores, high down payments, or low demand among younger homebuyers, in part because of the burden of student loan debt. Supply constraints also played a role, and the FOMC pointed to shortages of lots, low inventories of desirable homes for sale, an overhang of homes associated with foreclosures or seriously delinquent mortgages, and rising construction costs.
6. Business sentiment is showing signs of improvement
The FOMC minutes reflect a positive improvement in business sentiment among investors. According to participants, capital spending is likely to increase going forward. The interactions of the members with businesses in their districts seemed to reflect an optimistic outlook about business, while some were worried about fiscal constraints once the congressional budget agreement expired.
“Some participants commented that their contacts in small and medium-sized businesses reported an improved outlook for sales, and several heard businesses more generally discuss plans to increase capital expenditures,” the minutes said.