Federal Reserve officials want to tie an interest-rate rise to U.S. economic progress, but the minutes of their last policy meeting show they are struggling with how to come to grips with the dual threats of a stronger dollar and a global slowdown.
The minutes expressed concern the rising dollar could slow a needed rebound in inflation. They also highlighted economic turmoil in Europe and Asia, another factor behind the bank's keeping policy accommodation in place for the near future.
The minutes of the Sept. 16-17 meeting, released on Wednesday after the usual three-week lag, revealed concern the financial markets are slightly out of sync with the Fed, and that dropping the current policy guidance could send unintended signals.
In response, investors bid up U.S. stocks .SPX and bonds US10YT=RR, betting the Fed is in no rush to tighten after years of monetary stimulus. The U.S. dollar .DXY, which has risen in the last 12 weeks, hit a two-week low.
"The Fed is becoming increasingly focused on the potential impact of the stronger dollar on the domestic economy at a time when the global growth momentum is beginning to slow, and the uncertainties this is adding to the economic outlook," said Millan Mulraine, deputy head of research and strategy at TD Securities.
Debate within the Fed heated up over how to adopt a more "data-dependent" policy guidance.
Several policymakers fretted the current guidance that rates will not rise for a "considerable time" after October gave the false impression the stimulus would last a long while. Others worried a change could trip up financial markets and hurt the economy through higher borrowing costs.
The change would "likely present communication challenges" and "caution will be needed to avoid sending unintended signals about the Committee's policy outlook," the minutes said.
The extent of the debate suggests the committee could move as soon as its meeting on Oct. 28-29 to change its description of when it might begin lifting rates from near zero, where they have been since late 2008.
DELICATE DANCE
The minutes also showed concern from a "couple" of participants that the strengthening dollar could hurt the economy and cause longer-term inflation expectations to move slightly lower.
Since the meeting, Fed officials have increasingly flagged the dollar's rise as hindering a rebound. While unemployment dropped to 5.9 percent in September, inflation measures have eased and the International Monetary Fund slashed its global economic growth forecasts on Tuesday.
Some officials cited disappointing growth and inflation in the euro zone, while several said "slower economic growth in China or Japan or unanticipated events in the Middle East or Ukraine might pose a similar risk," the minutes show.
In response, investors bet on a later start to tightening.
"The deceleration of inflation from the spring and the rising strength of the dollar are noteworthy, and may mean the Fed may raise rates later than expected," said Anthony Valeri, investment strategist at LPL Financial.
U.S. 2015 short-term interest rate futures rose to contract highs on Wednesday, suggesting traders saw less than a 50 percent chance of a rate rise in July next year, according to CME Group's FedWatch.
Both Fed and Wall Street economists expect a rate rise to come around the middle of next year, but the central bankers expect tightening to be more aggressive than believed by the private sector.
The Fed acknowledged the market seems behind in this regard and suggested it could complicate matters when the time comes to raise rates.
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