US FOMC Meeting Minutes for Sept 21-22 2021 - Full TEXT
US FOMC Meeting Minutes for Sept 21-22 2021 - Full TEXT
Developments in Financial Markets and Open Market Operations
The manager turned first to a discussion of financial market developments over the period. Domestic financial conditions were little changed, on net, and remained highly accommodative. The spread of the Delta variant of the COVID-19 virus weighed on the near-term growth outlook and median respondents to the Open Market Desk's Survey of Primary Dealers marked down projections for gross domestic product (GDP) growth and revised up projections for inflation this year. Nonetheless, expectations for the trajectory of growth beyond 2021 were little changed. Implied forward inflation compensation two to four years ahead based on Treasury Inflation-Protected Securities (TIPS) increased modestly over the intermeeting period.
Regarding the outlook for monetary policy, market participants noted policymaker communications suggesting that tapering of asset purchases could begin this year and end by mid-2022. Around half of respondents to the Desk's surveys of primary dealers and market participants viewed December as the most likely timing of the first reduction in the net pace of purchases, al­though respondents also attached significant probability to the first reduction coming in November. Median expectations for the pace of net purchases were consistent with a gradual tapering of net purchases being completed in July of next year, about one to two months earlier than in the previous surveys. Expectations for the target federal funds rate based on survey responses and interest rate futures moved up slightly since the previous meeting.
Several central banks announced reductions in the pace of their asset purchase programs or eventual plans for their balance sheets once asset purchases had been completed. These announcements were broadly in line with market participants' expectations and elicited only a modest reaction in financial markets. In Latin America and emerging Europe, some central banks recently tightened policy to address rising inflation pressures. Investors remained focused on other vulnerabilities in emerging markets, and concerns had grown recently about the possible implications of developments in China.
The manager turned next to a discussion of money markets and Federal Reserve operations. Domestic funding conditions were stable over the period. The federal funds rate edged lower amid ongoing increases in reserves, but it remained well within the target range; the Secured Overnight Financing Rate (SOFR) was steady at 5 basis points. Participation in the overnight reverse repurchase agreement (ON RRP) facility increased to an average of just over $1 trillion over the period, driven primarily by increased usage by government money market funds. Market participants were attentive over the period to negotiations on the debt limit. Yields on Treasury bills maturing in mid-October to mid-November had become modestly elevated as investors reduced exposures to securities that could be at risk for delayed payments. Market participants noted information in the public domain about measures the Federal Reserve and the Treasury could take around a debt limit event. They pointed, in particular, to the October 2013 FOMC meeting minutes, which highlighted that the Federal Reserve would use normal procedures in its operations, both as the debt limit nears and in the event of a delayed payment. Market participants also focused on a 2013 report by the Treasury Market Practices Group (TMPG), which outlined a process that could be used to delay principal payments on Treasury securities by rolling forward the operational maturity date in order to maintain the ability to transfer such securities over Fedwire®. The TMPG report noted that such a procedure would help support ongoing functioning of markets for securities with delayed payments. This would maintain their eligibility in open market operations under normal procedures. Nevertheless, market participants emphasized that, even with these procedures, a delayed payment would create severe and broad-based market disruption.
In light of increased usage of the ON RRP facility and the potential for continued downward pressure on short-term interest rates over the near term, the manager next discussed a staff proposal to increase the per-counterparty limit for the ON RRP facility to $160 billion. Staff analysis suggested that the proposed increase was likely to be sufficient to support effective policy implementation for most foreseeable circumstances.
The manager provided a brief update on the new repurchase agreement (repo) facilities that the Committee had announced following its meeting in July. The Desk had been working to onboard depository institutions as additional counterparties for the standing repo facility. In addition, a number of foreign central banks had expressed intent to establish access to the Foreign and International Monetary Authority Repo Facility.
By unanimous vote, the Committee ratified the Desk's domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System's account during the intermeeting period.
Staff Review of the Economic Situation
The information available at the time of the September 21-22 meeting suggested that U.S. real GDP was increasing in the third quarter at a slower pace than in the second quarter of the year. The pace of improvement in labor market conditions had remained very rapid in July but slowed sharply in August. Consumer price inflation in June and July-as measured by the 12?month percentage change in the personal consumption expenditures (PCE) price index was elevated.
Total nonfarm payroll employment increased sharply in July but rose much less rapidly in August, with job gains in the leisure and hospitality sector slowing to zero. In addition, state and local government employment was reported to have fallen in August, though abnormal seasonal swings had likely distorted recent readings for this sector. As of August, total payroll employment had retraced three-fourths of the losses seen at the onset of the pandemic. The unemployment rate had declined from 5.9 percent in June to 5.2 percent in August; although the unemployment rates for African Americans and Hispanics had also declined, on net, over this period, both rates remained well above the national average. The labor force participation rate edged up, on net, and the employment-to-population (EPOP) ratio rose further in July and August. Private-sector job openings, as measured by the Job Openings and Labor Turnover Survey, increased further in July and continued to suggest that labor demand was extraordinarily high. Initial claims for regular state unemployment insurance remained near the pandemic-period low that had been reached in early September but were still somewhat elevated relative to pre-pandemic levels. Weekly estimates of private-sector payrolls constructed by the Board's staff using data provided by the payroll processor ADP that were available through early September pointed to a modest pickup in the pace of private employment gains relative to August.
Average hourly earnings for all employees rose strongly in July and August, with gains that were widespread across industries. Recent monthly increases in average hourly earnings appeared to reflect a combination of continued strong labor demand and increased difficulties in hiring. A staff measure of the 12-month change in the median wage derived from the ADP data had also pointed to strong wage growth, with a pace in August that was well above the growth rates seen before the pandemic. By contrast, the Wage Growth Tracker measure constructed by the Federal Reserve Bank of Atlanta had not shown a similar pickup. The employment cost index of hourly compensation in the private sector, which also includes benefit costs, rose at an annual rate of 3.6 percent over the 6 months ending in June, 1 percentage point faster than the 12?month change posted in December 2020.
Inflation, as measured by either the PCE price index or the consumer price index (CPI), had been boosted by a surge in demand as the economy reopened further, along with the effects of production bottlenecks and supply constraints. Total PCE price inflation was 4.2 percent over the 12 months ending in July, and core PCE price inflation, which excludes changes in consumer energy prices and many consumer food prices, was 3.6 percent over the 12 months ending in July. In contrast, the trimmed mean measure of 12?month PCE inflation constructed by the Federal Reserve Bank of Dallas was 2.0 percent in July. In August, the 12-month change in the CPI was 5.3 percent, while the core CPI rose 4.0 percent over the same period. In the third quarter of 2021, the staff's common inflation expectations index, which combines information from many indicators of inflation expectations and inflation compensation, was little changed relative to the second quarter and was near its average over the decade before the pandemic.
Although real PCE declined in July, the components of retail sales used to estimate PCE rose strongly in August, returning to levels seen in the spring. However, concerns about the course of the pandemic appeared to be weighing on consumer services spending, as available indicators pointed to a slowing in demand for services sensitive to social distancing. In addition, measures of consumer confidence had moved lower in August. Demand for housing appeared to have remained very strong, but incoming data suggested that materials shortages and a lack of developed lots for construction were restraining residential building activity.
Available indicators suggested that growth in business fixed investment was slowing somewhat in the third quarter as supply bottlenecks-particularly for motor vehicles-weighed on business equipment spending.
Manufacturing output rose strongly in July and ticked up further in August. In August, activity in the oil and gas sector and production of petrochemicals had been held down by shutdowns related to Hurricane Ida. Supply chain issues faced by a number of other industries also continued to be a drag on overall factory output.
Total real government purchases appeared to be increasing in the third quarter after having moved lower in the second quarter. Available data suggested that federal nondefense purchases were declining sharply in the third quarter but that robust gains in real state and local purchases were offsetting this decline.
The U.S. international trade deficit remained high in July. After rising in June, real goods imports fell back in July, held down by a sizable decline in consumer goods imports, but the levels of consumer and total goods imports remained well above pre-COVID-19 levels. Real goods exports edged up in July and were close to pre-pandemic levels. Bottlenecks in the global semiconductor industry continued to weigh on exports and imports of automotive products, and shipping congestion continued to restrain trade overall. Exports and imports of services rose again in July, but they remained low relative to pre-pandemic levels, largely because international travel was still depressed.
In the advanced foreign economies (AFEs), where high vaccination rates had increased resilience to COVID-19 outbreaks, incoming data were consistent with economic growth in the third quarter at a slightly faster pace than in the second quarter. With the economic reopening under way, purchasing managers indexes for both manufacturing and services remained strong in Europe and Canada. Conversely, in emerging market economies (EMEs)-especially in Southeast Asia, where vaccination rates were lower-a global resurgence in COVID-19 infections due to the Delta variant led to renewals of public health restrictions. These restrictions weakened retail sales and contributed to labor shortages and transportation congestion, disrupting global supply chains. Inflation abroad was elevated, reflecting reversals of price declines early in the pandemic, past increases in energy and commodity prices, upward pressures from supply bottlenecks, and past exchange rate depreciations in some EMEs.
Staff Review of the Financial Situation
Financial market prices were little changed over the intermeeting period. Concerns over the period about the effects of COVID-19 developments on economic performance and, late in the period, about a heavily indebted Chinese property developer appeared to have only marginal net effects on financial asset prices. The incoming domestic economic data were generally viewed as mixed. Yields on Treasury securities of intermediate maturities increased modestly, the market-implied path of the federal funds rate steepened, domestic equity prices were unchanged, and speculative-grade corporate bond spreads narrowed modestly. Short-term funding markets were stable. Market-based financing conditions were robust, and credit availability improved for riskier borrowers.
Yields on intermediate-maturity Treasury securities increased modestly, on net, amid mixed news on economic activity and the pandemic, and slightly less-accommodative-than-expected July FOMC communications. Measures of inflation compensation declined modestly, on net. The market-implied level of the effective federal funds rate for the ends of 2023 and 2024 rose 12 and 17 basis points, respectively.
Broad stock market prices were about unchanged, on net, over the intermeeting period. Early in the period, concerns over the Delta variant were a headwind for stock prices. Prices recovered following the FDA's first full approval of a COVID-19 vaccine and signs that the Delta variant surge was starting to abate. Over the intermeeting period, spreads of yields on speculative-grade corporate bonds over those on comparable-maturity Treasury securities narrowed slightly, on net. Investment-grade corporate bond spreads were little changed, on net, and spreads of municipal bond indexes increased slightly but remained well below pre-pandemic levels. On September 20, stock market prices fell notably and speculative-grade yield spreads widened amid rising concerns about the creditworthiness of a Chinese property developer, but these moves were mostly reversed during the following day, particularly in the stock market.
Short-term funding markets were stable over the intermeeting period. The effective federal funds rate declined slightly, from 10 basis points at the beginning of the period to 8 basis points at the end, while the SOFR remained at 5 basis points throughout the period. Assets under management (AUM) of government money market mutual funds increased modestly to near all-time highs. Treasury bill supply continued to decline with the reinstatement of the debt ceiling. Higher AUM together with declining Treasury bill supply led government money market mutual funds to increase their participation at the Federal Reserve's ON RRP facility. Participation in ON RRP operations increased from an average of $808 billion over the previous intermeeting period to $1.08 trillion.
Foreign asset prices fluctuated moderately over the intermeeting period as market participants continued to assess the effect of the Delta variant on global growth and inflation. Concerns about a potential default by a heavily indebted Chinese property developer and risks of a downturn in the Chinese real estate sector intensified later in the period, but effects on broader financial markets were limited. On balance, major foreign equity indexes were mixed, the broad dollar appreciated a touch, and sovereign yields in most major AFEs increased moderately. In the euro area and the United Kingdom, higher-than-expected inflation data contributed to the rise in yields and inflation compensation measures.
In domestic credit markets, large nonfinancial firms had ample access to market-based financing as market participants appeared confident in the domestic corporate credit outlook. After accounting for the seasonal summer lull in activity, gross corporate bond issuance remained solid in July and August. Leveraged loan issuance was also strong in July and August. Equity funding raised through traditional initial public offerings remained robust over the summer, while equity issuance through special purpose acquisition companies remained at the subdued levels seen in recent months. Commercial and industrial (C&I) loans declined notably through August, amid ongoing forgiveness of Paycheck Protection Program (PPP) loans. Excluding PPP loans, C&I loan balances were estimated to have been largely unchanged between June and July.
The credit quality of large nonfinancial corporations remained strong with a positive outlook. The volume of credit rating upgrades for nonfinancial bonds outpaced downgrades noticeably in July and August. Trailing default rates on corporate bonds and leveraged loans remained low, as did market indicators of future default expectations.
In the municipal bond market, financing conditions remained accommodative. Issuance of municipal debt was strong in July and August and indicators of credit quality of municipal debt remained healthy, though municipal bond impairments-that is, credit events that are less severe than payment defaults-remained elevated in August. These impairments were concentrated in the retirement and assisted living sector and represent a very small fraction of the municipal market.
Survey-based indicators suggest small business owners, especially from COVID-sensitive sectors that include lodging and food services, arts, entertainment and recreation, and educational services, became more pessimistic about their financial prospects, largely because of a worsening of near-term expectations for sales and general business conditions. Small business loan originations were above pre-pandemic levels in June and July, but increased concerns about the Delta variant depressed loan demand in August.
Financing conditions in commercial real estate (CRE) improved over the intermeeting period amid increasing CRE property prices. CRE loan growth at banks strengthened and issuance of commercial mortgage-backed securities (CMBS) remained robust over the summer. Spreads of agency CMBS were generally at or below pre-pandemic levels. Strong investor appetite for CMBS was supported by falling delinquency rates on mortgages, al­though delinquency rates remained elevated for CMBS backed by hotel and retail properties. Financing remained limited for the hard-hit hotel sector.
In the residential mortgage market, financing conditions remained accommodative particularly for borrowers who met standard conforming loan criteria. Mortgage rates increased slightly over the intermeeting period but remained very low by historical standards. Credit availability continued to improve, especially for jumbo loans and lower-score Federal Housing Administration borrowers. Indicators of mortgage originations for home-purchases and refinancing were solid through August. The share of mortgages in forbearance declined further in July and August.
Financing conditions for consumer credit remained accommodative for most borrowers, especially those with stronger credit scores. Consumer credit and the credit card market expanded at a strong pace in June before stepping down somewhat in July. Conditions for nonprime consumers in the credit card market eased from tight levels. Auto loan growth slowed in June and July from its brisk pace in May. Conditions in the asset-backed securities market were robust over the intermeeting period.
Staff Economic Outlook
The projection for U.S. economic activity prepared by the staff for the September FOMC meeting was broadly similar to the July projection. In the second half of 2021, supply constraints were expected to resolve more slowly than previously assumed;