Brighter U.S. Growth Outlook Emboldens Fed on Rate-Hike Course

(Bloomberg) -- U.S. central bankers sent a strong message Wednesday that an expansion with “substantial underlying economic momentum” could sustain additional increases in interest rates this year.

Federal Reserve officials “anticipated that the rate of economic growth in 2018 would exceed their estimates of its sustainable longer-run pace and that labor market conditions would strengthen further,” the minutes of their Jan. 30-31 meeting released in Washington on Wednesday showed. A number of participants “indicated that they had marked up their forecasts for economic growth in the near term relative to those made for the December meeting.”

Their collective position on inflation, meanwhile, remained one of cautious optimism that it will move toward their 2 percent target in the medium term.

Stocks reversed gains and bond yields rose after the minutes revealed a more hawkish posture among Fed officials. The S&P 500 Index ended the day down 0.6 percent after being up as much as 1.2 percent earlier. The yield on 10-year Treasuries rose to 2.94 percent -- a four-year high -- at 4 p.m. in New York.

The minutes also marked the end of Chair Janet Yellen's tenure at the central bank, as she turned the reins over to Jerome Powell in early February.

The new chairman appears before the House Financial Services Committee for his semi-annual testimony on Feb. 28, and economic reports since the Federal Open Market Committee last met are unlikely to change the message from the January policy statement that said “further gradual increases” in interest rates are in store for the economy.

Data released after the Fed meeting showed the unemployment rate holding at 4.1 percent in January, while the consumer price index, excluding food and energy, was 1.8 percent for the 12 month period. Retail sales unexpectedly declined from the prior month.

The key question facing policy makers is now one of pace -- whether three hikes or four will be sufficient to keep supply and demand in balance as corporations take advantage of lower tax rates and aggressive incentives to ramp up investment resulting from the fiscal stimulus signed into law in December.

“The Fed is finding more confidence in their baseline outlook,” said Harm Bandholz, chief U.S. economist at UniCredit Bank AG, who is forecasting three more rate increases for 2018. “The risk of four” rate hikes “is higher than two.”

Fed officials estimated economic growth at 2.5 percent for 2018 in December. Private analysts have boosted their outlook to 2.6 percent, according to the median forecast in a Bloomberg News survey. Stocks peaked on Jan. 26 before tumbling at the start of February, and longer-term government bond yields began to climb on the prospects of larger amounts of Treasury issuance.

Financial Risks

Participants also discussed numerous uncertainties about the outlook, the minutes showed. Several cautioned that “imbalances in financial markets may begin to emerge as the economy continued to operate above potential,” the minutes said. Fed officials also speculated on whether the tax cuts would translate into higher compensation for employees.

“It was noted that the pace of wage gains might not increase appreciably if productivity growth remains low,” the minutes said. “That said, a number of participants judged that the continued tightening in labor markets was likely to translate into faster wage increases at some point.”

The January meeting opened with staff presentations on inflation. The central bank has missed its 2 percent inflation target for most of the past five years. “Participants emphasized the critical need for the FOMC to maintain a credible longer-run inflation objective,” the minutes said.

--With assistance from Christopher Condon

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

To contact the editors responsible for this story: Brendan Murray at brmurray@bloomberg.net, Randall Woods

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