By Nick Timiraos 

WASHINGTON-Federal Reserve officials signaled growing optimism about the U.S. economy last month, before the coronavirus outbreak in China began to cloud prospects of firmer global growth in 2020.

Officials at the Fed's Jan. 28-29 policy meeting mostly "saw the distribution of risks to the outlook for economic activity as more favorable than at the previous meeting, although a number of downside risks remained prominent," according to minutes released Wednesday.

No sooner had the U.S. and China signed a deal that eased trade tensions last month than the coronavirus outbreak in China rekindled doubts about the global economy's prospects in 2020.

The minutes referred eight times to the coronavirus outbreak. Officials agreed the potential for disruptions from the virus "warranted close watching," the minutes said.

The Fed cut its benchmark rate at three consecutive meetings last year, to a range between 1.5% and 1.75%, after judging that any chill to business spending from trade uncertainty threatened to worsen slowing global growth. Officials held the rate steady at their last two meetings, in December and January, and indicated no urgency to reverse the cuts.

Trade uncertainty last year complicated Fed officials' approach to setting interest rates because they try to forecast the most likely path for the economy while minimizing the potential to make errors that are costly to fix.

The coronavirus is another curveball for the Fed because the range of potential outcomes for the global economy appears wide. One possibility is a modest outbreak that, like SARS in 2003, is contained within weeks and doesn't leave a lasting imprint on global investment and spending.

But the situation could be worse if efforts to contain the outbreak inflict a heavy toll on the Chinese economy and global supply chains at a moment when other advanced economies, in Germany and Japan, have slowed.

Fed Chairman Jerome Powell told lawmakers last week the central bank will want to see evidence that disruptions stemming from China, the world's second-largest economy, are persistent and material for the U.S. economy before it would consider cutting interest rates.

"There's no way to be confident about anyone's assessment, and there are a range of assessments," he said.

China serves as the hub of global supply chains for numerous products, including cars and computer chips. Beijing has imposed quarantines that have idled factories, while air travel to the country has been curtailed.

Investors in interest-rate future markets increasingly expect the Fed to lower rates later this year. Fed officials have said it is too soon to determine.

"If the situation gets significantly worse and we start to see significant impact on the U.S. economy, then we'd have to think about accommodation. But I don't think we're at that point right now," said Philadelphia Fed President Patrick Harker during a moderated question-and-answer session last week. "We just need to let this play out."

The minutes said most officials last month were more confident that with solid economic growth and continued hiring, inflation would gradually return to the Fed's 2% target after the central bank's preferred inflation gauge ran closer to 1.6% last year.

But a few officials said they were less confident in this outlook because inflation had consistently defied forecasts of a return to 2%.

As part of a yearlong review of their inflation-targeting framework, officials debated proposals to adopt an inflation range around their 2% target. One such variant discussed last month would signal a desire to seek inflation in the higher end of the range to make up for past misses below 2%.

But the minutes said most officials expressed concern that introducing such a range after years of below-target inflation could be interpreted by the public that the Fed was comfortable with inflation running below 2%.

Separately, the manager of the Fed's open-market operations outlined a proposal to phase out two-week loans backed by government securities, called repurchase agreements, or repo, after April. By that point, officials expect the Fed will have sufficiently rebuilt reserve balances in the banking system to $1.5 trillion.

Overnight lending rates spiked in mid-September, leading the Fed's benchmark rate to briefly trade outside of its target range, after reserves fell below $1.4 trillion. Officials subsequently announced plans to replenish reserves in the banking system by conducting repo lending and by purchasing Treasury bills.

Now, attention has focused on winding down these programs as reserves rise, ending a period of sudden growth in the Fed's balance sheet. The Fed's market-operations manager indicated the central bank could slow its $60 billion-per-month pace of Treasury bill purchases in the second quarter. The minutes said most Fed officials were comfortable with this proposal.

(END) Dow Jones Newswires

February 19, 2020 14:15 ET (19:15 GMT)

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