What to Look for in Tomorrow's Fed Minutes

Here's what I'll be keeping an eye out for tomorrow when the Federal Reserve releases minutes from October's monetary-policy meeting.

The news release that the Fed put out immediately after the session sparked expectations for a December rate hike, based mainly on two tweaks from what the central bank had said following September's meeting.

First, the Fed removed a line citing global economic weakness as a downside risk.

But more importantly, the central bank changed the language around a possible rate liftoff. In September, it wrote: "In determining how long to maintain (current rates), the committee will assess progress -- both realized and expected -- toward its objectives."

But in October, the Fed changed that to: "In determining whether it will be appropriate to raise (rates) at its next meeting, the committee will assess progress -- both realized and expected -- toward its objectives."

Hopefully, tomorrow's release will provide some insight as to why Fed members made the above adjustment. Were they just trying to gain some flexibility to hike if they wanted to, or did they intend to signal a strong likelihood that a hike is coming in December?

Here are some other things I'll be keeping an eye out for:

Divergence Between U.S. Manufacturing and Services

We haven't heard much from the Fed about what they make of the dispersion between America's manufacturing and services sectors.

The manufacturing economy is doing poorly. The ISM Manufacturing Index is at 50.1, suggesting almost no growth at all. Factory orders excluding transportation have also declined three months in a row and are now down 8% since their June 2014 peak. Part of the problem is directly attributable to monetary policy -- a strong U.S. dollar hurts factory exports.

By contrast, services and domestic construction are doing just fine. The ISM Non-Manufacturing Index just printed at 59.1, the second highest read since the recession ended. (The highest was just in July.) Housing starts are also strong and services employment is growing rapidly.

Should the Fed figure that the strength in services -- which is the vast majority of the U.S. economy -- outweighs the weakness in manufacturing and hike rates? I think it's absolutely crucial to determine what the Fed thinks on this issue, as that'll give us important intelligence about 2016 monetary policy.

Manufacturing's problems will likely persist for at least several months, thanks to a strong dollar plus a lack of energy-sector investment spending. So, the odds are good that manufacturing will still look weak in 2016 even as the economy's services side will remain strong.

If Fed members are comfortable with that, we might get a more-rapid hiking cycle. If they're not, expect a more-halting series of hikes.

Look for statements in tomorrow's minutes like: "Some members expressed concern that the weakness in manufacturing could spread to other parts of the economy."

Or alternatively, the Fed might say: "Some members commented that since manufacturing makes up a small part of the labor force, weakness in that sector should not have a large impact on unemployment."

Effectiveness of Remaining at 0%

The impetus for curtailing the Fed's Quantitative Easing program in 2014 was a growing consensus that the buys were having little positive impact. Thus, maintaining the program was all risk and no reward.

Well, some very prominent economists argue today that higher interest rates will somehow have a positive impact on spending and/or business investment. I'm not convinced, but should the Fed decide that zero rates aren't having any positive impact, that would make it far easier to conclude that rates should rise.

There's a good economic basis for this. Textbook economics holds that once the economy reaches full employment, stimulative monetary policy has no impact other than causing inflation.

We aren't seeing inflation now, but we weren't seeing any particular downside to QE, either. Instead, the Fed merely concluded that there wasn't any upside to QE any more, so why take the risk of problems emerging?

We could see some discussion on this point in tomorrow's minutes. That would go a long way to explaining why the Fed choose to make the language changes mentioned earlier. Speaking of which, I'll also be looking at ...

Language Changes: A Compromise, or Communications Strategy?

It's generally assumed that Fed chair Janet Yellen prefers to build as large a consensus as possible before publishing the central bank's post-meeting statement. This might require some alterations to the language used to assuage either the more-dovish or hawkish members' concerns.

It could be that at the October meeting, some hawkish members felt strongly enough about a December rate hike that they wanted to send markets a clear signal about that possibility. That could explain why the Fed statement changed the way it did between September and October.

But if that's true, then the language change doesn't necessarily mean a December rate hike is a shoo-in, just that Fed members are open to such a decision.

Or, it could mean that there is a general consensus that December is probably the right time for a liftoff. In that case, the change in language does represent a communications strategy of readying the markets for a likely rate hike.

We won't get anything really explicit on this tomorrow -- the Fed won't publish something like: "Most members think December is the right time to start normalization."

But there will probably be some discussion about each of the two language changes above. And if we read between the lines carefully, we should get some sense of whether the modifications represented a compromise or a planned communication.