A divided Federal Reserve left open the prospect of a further interest rate rise this year even as policymakers insisted they needed more evidence on the durability of the rebound before feeling confident enough to pull the trigger.
Minutes to their latest July meeting revealed a hard-fought debate over when to move rates, with a couple of participants urging an immediate move, while others were urging caution amid questions over how rapidly inflation will return to target.
Fed officials generally agreed that a strengthening of the jobs market and the relatively benign market reaction to the UK’s vote to leave the European Union in June meant some of the uncertainties that had hung over the US economy had diminished.
But there was no consensus on the urgency of a second rate rise since last December, given the mixed prospects at home and abroad. Even as the Fed held rates unchanged during the meeting, two participants wanted to see an immediate move. Others said an increase would “soon be warranted.”
Several other participants were more cautious, according to the minutes. They said the Federal Open Market Committee would have “ample time” to react to a rise in inflation if needed and preferred to wait until they were more confident that price growth was heading sustainably to the Fed’s 2 per cent target.
Treasury yields fell and the dollar gave up its gains as the market took the view that interest rates will stay lower for longer.
The rally in the US Treasury market was extended, with the 10-year US government bond yield down 2.5 basis points at 1.54 per cent. The interest rate sensitive two-year yield also rose 2.2 bps to 0.724 per cent while the dollar, as measured by the DXY index, reversed its gains to trade 0.3 per cent lower.
In another sign of Wall Street’s dovish interpretation of the minutes, the S&P 500 utilities sector, which is favoured for its dividend yield and has performed well in the low-rate environment, rose 1.2 per cent, extending an advance from earlier in the day.
“Hawks balanced with doves and the Fed in wait and see,” said Kit Juckes, strategist at Societe Generale. “I don’t think this tells us much about the September meeting, which is, as ever, data and market-dependant, but it does tell us that the most we’ll get is a very slow and cautious tightening path.”
Having lifted short term interest rates by a quarter-point in December, the Fed has held fire this year as policymakers weigh competing forces influencing the economy both at home and from overseas.
Growth is expected by economists to pick up in the third quarter following a soggy performance in the second quarter and, after a pause in May hiring, in the labour market has regained momentum, holding the unemployment rate at 4.9 per cent. Wage growth is now at its fastest since the end of the financial crisis.
However inflation remains comfortably below the 2 per cent target, prompting some officials to call for caution before pulling the trigger on a second rate increase. Global events have this year also had a tendency to foil arguments within the Fed for a second rate rise, with risks abroad continuing to weigh on officials’ minds.
The UK’s vote to leave the EU helped convince the central bank to hold fire in June, for instance, while extreme volatility in the foreign exchange markets associated with confusion over Chinese policy pinned the Fed to the sidelines earlier in the year.
Officials including Jerome Powell, a Fed governor, have argued that policy loosening by central banks overseas is also making it trickier for the Fed to tighten.
Central bankers have also hinted that even if the Fed does lift rates again, it may not need to tighten by much.
Fed policymakers’ estimate of long-term fed funds rate centre around 3 per cent, compared with a range of 0.25 to 0.5 per cent now.
Many analysts expect the longer-term projection to fall further given fears that the US may be mired in a long period of mediocre growth which requires relatively low interest rates.
This does not, however, mean the Fed will do nothing at all with its target rate. Bill Dudley, the New York Fed president, has been vocal in telling market participants that they are underestimating the prospects for a second move upward given signs of strength in the economy and the potential for inflation to accelerate.
This week Mr Dudley, who is highly influential within the Federal Open Market Committee, insisted that an increase was possible in September, when the Fed meets next.
If it does not move then, the next opportunity in 2016 will be its final meetings in November and December. The central bank would be very reluctant to tighten policy if the move caught financial markets off guard.
Further complicating the calculus is the US presidential campaign, which ends in the November 8 election, with some analysts arguing the central bank would be reluctant to wrongfoot markets at a time when a highly sensitive election is looming.
Fed officials insist that they set policy without regard to politics and campaign timetables.
Additional reporting from Pan Yuk in New York
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