Investors’ interest in the minutes of the April 26-27 Federal Reserve meeting that were released Wednesday increased notably after some central bank officials suggested earlier that markets may be underestimating the probability of an interest rate increase as early as this summer. The Fed did not disappoint.
Here are five key takeaways from the minutes:
1. Echoing the recent statement of three Fed regional presidents, the minutes indicated that members of the Federal Open Market Committee were worried that markets were underestimating the possibility of an early rate hike. Fed officials sought to correct this misconception, including by spelling out developments that could warrant an increase as early as June.
2. This notable signal reflected Fed expectations that the all-important labor market would continue to strengthen, improving prospects for economic activity and inflation over the medium term. Officials also welcomed the recent decline in risks posed by global economic and financial conditions. And they noted that the domestic outlook was further enhanced by significant improvements in U.S. and international financial conditions.
3. This policy posture was accompanied by qualifications, which restrained the Fed from giving a more definite message regarding June. After all, the central bank’s preferred measure of inflation is still running below the 2 percent objective, and the international environment is far from risk-free. Another consideration is the big event risk posed by the June 23 vote on the the U.K.'s membership in the European Union.
4. Market action before and after the release of the minutes confirmed once again the extent to which financial asset prices remain sensitive to perceptions of the Fed’s policy stance. In anticipation of the release, traders had started to reprice the probability of a Fed hike. This was reflected in the upward move in yields on 2-year Treasuries -- the maturity most sensitive to Fed action -- the probability rise indicated by the Fed funds futures, or the flattening of the yield curve, led by the front end and to an extent not seen since December 2007. This repricing accelerated markedly Wednesday afternoon, with large yield spikes, particularly for 2-year and 5-year Treasuries.
5. These developments yield another important conclusion: After a period of persistent dovishness and prolonged reliance on unconventional monetary policies, the Fed should now be characterized as a central bank that is inclined to gradually normalize policy absent a major domestic and international economic calamity. The likelihood of at least one rate increase in 2016 is almost a done deal, most probably this summer. The probability of this being followed a second hike, while less certain, should not be dismissed too readily.
Mohamed El-Erian is chief economic advisor at Allianz SE.