FOMC minutes warn of higher current account deficits

Tuesday, May 24, 2005

The members of the Federal Open Market Committee (FOMC) seem to get a bit more concerned about the inflation outlook due to anticipated brisk growth in imports that is likely to stay. As the high imports are not matched by export growth due to economic weakness in other countries "the US economy was expected to continue run quite substantial current account deficits," although the (recently reversed) depreciation of the dollar should help exports.

According to the FOMC minutes from the May 3 meeting released today, members interpreted the recent weak economic data as a soft patch that has to be seen in the context of the high noise high frequency indicators can produce. While the economic outlook remained to be seen as robust, energy prices will remain on the high alert list as they were responsible for an uptick in core inflation rates, the participants agreed. High energy prices were mentioned several times in the minutes. Interestingly the latest minutes describe some sectors of the real estate market with the word "hot", while the previous minutes mentioned only a "softness" in the housing market.
As always the meeting contained the note that the Fed was on guard and would "respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."
Interest rate policy is likely to remain on its measured path regarding the overall tone of the FOMC minutes that stayed in equilibrium between continued solid growth and inflation concerns voiced in the previous minutes as well, although inflation seems to be a growing concern for a growing number of FOMC members.
A compilation of the forward looking paragraphs of the FOMC minutes
In their discussion of current conditions and the economic outlook, meeting participants observed that incoming data over the intermeeting period hinted at possible upside risks for inflation and downside risks for economic growth. Earlier increases in energy prices seemed to be an important factor contributing to an uptick in core inflation and a slower pace of economic activity. With energy prices leveling out more recently, however, and the behavior of compensation suggesting a lack of pressure in labor markets, underlying inflation appeared to remain contained. The weakness in spending was widespread and could not be completely dismissed, but it had appeared only very recently and could be a product of the inherent noisiness of high-frequency economic data. On balance, economic fundamentals including low interest rates, robust underlying productivity growth, and strengthened business balance sheets were expected to support economic growth at a pace sufficient to gradually eliminate remaining slack in resource utilization. Although the economic outlook generally seemed favorable, there was also broad recognition of greater uncertainty attending the outlook for both inflation and output growth.
Capital expenditures advanced briskly over the first quarter, but at a pace significantly below that registered over the latter half of last year.
Incoming data for the household sector were viewed as mixed. Higher gasoline prices seemed to be sapping consumer confidence and consumer spending. The pace of consumption growth had fallen off appreciably toward the end of the first quarter, and some participants worried about the potential for continued sluggishness in consumer spending if increasingly cautious households sought to raise their saving rate rapidly. On balance, though, strong income growth and low interest rates augured well for household spending. Although housing starts had dropped of late, home sales and other indicators of activity in the residential real estate market remained at very high levels. House price appreciation was expected to moderate over coming quarters, but a number of local real estate markets were still regarded as "hot," with signs of possible speculative excesses in some areas.
A relatively high proportion of demand had continued to be met by imports. Some concern was expressed that incoming data suggested weaker growth in some of our major trading partners, which posed a downside risk to forecasts for U.S. exports. Moreover, advances in domestic income were expected to contribute to brisk growth in imports. Looking ahead, the U.S. economy was expected to continue to run quite substantial current account deficits, although the impact of past dollar depreciation should work to boost exports and slow the rise in imports to some extent. NOTE: The dollar has risen from 1.29 to 1.26 Euros since the latest FOMC meeting.
Recent energy price developments garnered considerable attention. Declines in energy prices in recent weeks were viewed as welcome, but participants noted that far-dated futures prices for oil remained quite elevated and that persistently high energy prices could trigger a range of deleterious effects on the economy. High energy prices appeared to be taking a toll on household and business confidence and might be beginning to crimp corporate profits.
Participants voiced concerns about recent price trends; they expected inflation to remain contained but also perceived that the risks to that inflation outlook now might be skewed somewhat to the upside. Core measures of price inflation had moved up over recent quarters and particularly so over the last few months. A discernable upcreep was apparent in survey measures of short- and, to a limited extent, long-term inflation expectations over recent months. Moreover, there were risks that the relative stability of long-term survey measures of inflation expectations could simply reflect lags in households' perceptions of changing economic prospects. The success that some businesses seemed to be encountering in passing through cost increases raised the possibility that competitive pressures and resource slack were exerting somewhat less restraint on inflation than had been anticipated.
Although downside risks to sustainable growth had become more evident, most members regarded the recent slower growth of economic activity as likely to be transitory. In this regard, the ability of the U.S. economy to withstand significant shocks over recent years buttressed the view that policymakers should not overreact to a comparatively small number of disappointing indicators, especially when economic fundamentals appeared to remain quite supportive of continued solid expansion.
Recent energy price developments garnered considerable attention. Declines in energy prices in recent weeks were viewed as welcome, but participants noted that far-dated futures prices for oil remained quite elevated and that persistently high energy prices could trigger a range of deleterious effects on the economy. High energy prices appeared to be taking a toll on household and business confidence and might be beginning to crimp corporate profits. In some cases, firms seemed to be more successfully passing on energy costs to their customers. Indeed, some portion of recent elevated inflation readings probably represented, at least partly, such pass-through effects from higher energy costs. However, while pass-through effects could leave the overall price level higher, their impact on inflation should fade over time, as long as inflation expectations remain well contained. Still, considerable uncertainty surrounded the degree of pass-through from energy prices to core consumer prices, and pass-through effects might be more pronounced when energy price increases were perceived as more likely to be permanent. Persistently high energy prices were mentioned as a factor that could trim the level of potential output to a small degree over time, possibly contributing to additional upward pressure on consumer prices at the margin.

In hindsight of today's OECD forecasts for the major industrialized countries the US economy will have to rely on a new dollar weakness in order to support the worrying trend in exports which stayed flat according to the latest trade figures. This in turn might be prevented by the recent strength of the US dollar that might continue to hold on to its recent gains in light of the growing interest rate differential that will continue to attract capital inflows as long as growth rates will stay in line with the current solid projections.
Share and bond markets presented themselves almost unmoved after the release of the minutes.
NOTE: For some interesting Fed insights jump to Tim Iacono's young blog The Mess That Greenspan Made.
Elsewhere in blogosphere so far only Mark Thoma commented on the FOMC minutes.
ADVICE: David Altig's macroblog features a weekly forecast for the future Fed Funds rate.

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