Federal Reserve minutes from December released today were last squawk from the inflation doves

If you try to interpret the minutes released today from the Federal Reserve’s December 12-13 meeting without factoring in the departure of key players at the central bank, I think you’ll get the meaning of that meeting exactly wrong.

On the surface, the minutes seem to show a Fed with strong reservations about raising interest rates. The presidents of two regional Federal Reserve banks, Neel Kashkari of the Minneapolis Fed and Charles Evans of the Chicago Fed, dissented from the decision at that meeting to raise the Fed’s benchmark Fed funds rate by another 25 basis points.

But both Kashkari and Evans are rotating off the Fed’s rate-setting body, the Open Market Committee, removing two voices in favor of going slow in the absence of concrete evidence that inflation is ticking up.

And in addition, the central bank will be losing its core of relatively dovish leadership with the departure at the end of this month of current Fed chair Janet Yellen and the 2017 departure of Fed vice chair Stanley Fischer and the announced departure of New York Fed President William Dudley sometime around the middle of 2018. Those influential members have argued that the Fed does indeed need to raise interest rates even with current low inflation readings so the bank doesn’t fall behind inflationary expectations, but they have argued for a very, very gradual approach that telegraphed every move well in advance in order not to spook the financial markets or stress the U.S. economy.

The replacements for the departing leadership and the Fed presidents rotating off the Open Market Committee certainly can’t be described as bomb-throwing radicals on interest rates. They are bankers, after all. But as a group I think it’s fair to say that while the departing figures thought that very, very gradual interest rate increases were enough to keep the Fed ahead of any rise in inflation expectations, these new Fed members worry that the Federal Reserve is in danger of falling behind the curve on inflation. So, for example, Evens and Kashkari are being replaced by more hawkish Fed presidents such as Cleveland’s Loretta Mester. And President Donald Trump has nominated Carnegie Mellon professor Marvin Goodfriend, who has criticized Fed policy for falling behind the curve on inflation, to fill one of the open governor slots at the bank. New Fed chair Jerome  Powell won’t, at least initially, have Yellen’s clout at the bank and may face more vocal opposition within any Fed consensus. It’s not exactly clear where new vice chair for supervision, Randal Quarles, will fall on the inflation spectrum.

The Fed has indicated that it intends to raise rates three times in 2018. Much of the market still seems to believe in just two interest rate increases this year although a growing number of economists at big Wall Street banks are now saying they can see four moves on interest rates this year.

At a minimum all this is a recipe for more uncertainty and less clarity on interest rate policy than the markets have grown accustomed to from a Janet Yellen Fed.

The next meeting of the Fed’s Open Market Committee is scheduled for January 31. The consensus market view is no interest rate increase at that meeting and that the Fed will hold off on raising rates until its March meeting.