FOMC stops just short of dropping the “H” word

The minutes of the last meeting (30 April 2024 – 1 May 2024) of the Federal Open Market Committee (FOMC) of the US were released last week. The discussion provides a decent insight into the policymakers’ thought process about the near-term economic outlook and the likely policy direction.

In my view, the most notable part of the FOMC discussion was the mention of a scenario that may warrant further tightening of policy. Though the participants may not have specifically mentioned the term “Rate Hike” it was very close. The minutes read, “Various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate.” This is perhaps the first time in the past six months that FOMC participants have explicitly mentioned the likelihood of policy tightening.

The FOMC participants noted that data indicated continued strong economic growth. They, therefore, sounded circumspect about the restrictiveness of the current policy stance. They noted some progress on the inflation front, but found the data pointing “to inflation being more persistent than previously expected and to a generally resilient economy”.

The participants noted that the market expectations from the policy has shifted materially in response to the resilient economic growth and persistent inflation. “The policy rate path derived from futures prices implied fewer than two 25 basis point rate cuts by yearend. The modal path based on options prices was quite flat, suggesting at most one such rate cut in 2024.”

Some of the notable points in the FOMC minutes could be listed as follows:

·         Model estimates suggested that inflation expectations rose some, but mostly at shorter horizons. Longer-term inflation expectations appeared to remain well anchored. The possibility that geopolitical events could generate commodity price increases, pose an upside risk to inflation. It would take longer than previously anticipated to gain greater confidence that inflation was moving sustainably toward 2 percent.

·         The recent monthly data has shown significant increases in components of both goods and services price inflation. The disinflation process would likely take longer than previously thought. Increased efficiencies and technological innovations could raise productivity growth on a sustained basis, which might allow the economy to grow faster without raising inflation

·         The dollar strengthened as several foreign central banks were expected to start easing policy before the Federal Reserve.

·         The valuations across a range of markets appeared high relative to risk-adjusted cash flows. The assessment of vulnerabilities in asset valuations is raised to elevated.

·         Labor demand and supply continued to move into better balance, though the speed of this realignment appeared to have slowed in recent months.

·         Foreign GDP growth is estimated to have picked up in the first quarter from its subdued pace in the previous quarter. In Europe, economic activity resumed expanding following modest contractions in several economies amid monetary policy restraint and the repercussions of the 2022 energy shock. Growth stepped up in China, led by strong exports, but property-sector indicators remained weak. Elsewhere in emerging Asia, exports rebounded further from last year’s lows, lifted by robust global demand for high-tech goods.

·         The risks around the forecast for economic activity were seen as skewed to the downside on the grounds that more-persistent inflation could result in tighter financial conditions than in the staff’s baseline projection; in addition, deteriorating household financial positions, especially for lower-income households, might prove to be a larger drag on activity than the staff anticipated.

·         A range of risks are emanating from the banking sector, including unrealized losses on assets resulting from the rise in longer-term yields, high CRE exposure, significant reliance by some banks on uninsured deposits, cyber threats, or increased financial interconnections among banks.

·         Although monetary policy is seen restrictive, many participants were uncertaint about the degree of restrictiveness. They saw this uncertainty as coming from the possibility that high interest rates may be having smaller effects than in the past, that longer-run equilibrium interest rates may be higher than previously thought, or that the level of potential output may be lower than estimated.

My impression from the FOMC discussions is that even though the ‘Rate Hike’ is not mentioned in the minutes; it is clear that the status quo might last longer than anticipated (higher for longer). There is a fair degree of uncertainty over the Fed's next move. Presently the market is forecasting a 25-50 bps cut in the Fed’s target range for bank rate, a 25bps hike in the next 12 months cannot be completely ruled out.