Fed Minutes Point To ‘Flexibility’ On Rates As Inflation Remains Key Focus

The Federal Reserve concluded 2022 with a firm promise at its December policy meeting that interest rates would continue increasing in 2023, but at a reduced pace and perhaps only by another 0.75 percentage points.

That session’s readout, due to be announced at 2 p.m. EST (1900 GMT) on Wednesday, may offer further insight into just how the endgame of the current tightening cycle will pan out, and how keenly U.S. central bank officials are starting to weigh risks to economic growth against their top-of-mind concern about inflation.

New data published on Wednesday gave little sense that the U.S. job market is starting to shrink in the manner Fed officials hope will allow inflation to reduce without a significant loss of employment. The number of job vacancies changed little in November, and remained high with respect to the number of job seekers – a data point Fed Chair Jerome Powell has underlined as a signal of continued rapid wage rises that could spark future inflation.

The Labor Department’s employment report for last month is due to be published on Friday, with the latest consumer inflation data coming next week, both key benchmarks as the Fed plan its next policy move.

The overall tone of the upcoming minutes is likely to reveal inflation continued to have prominence among policymakers at their Dec. 13-14 meeting. The pace of price hikes has been reducing for several months, but as of November the Fed’s preferred inflation gauge – the personal consumption expenditures price index – was still climbing at a 5.5% annual rate, more than double the Fed’s 2% goal.

In an essay published on Wednesday, Minneapolis Fed President Neel Kashkari said he felt interest rates would need to be jacked up slightly higher than the majority of his colleagues predict, and go up even more if inflation does not slow as anticipated.

“It will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked,” wrote Kashkari, who said he sees a possible stopping point for the federal funds rate at around 5.4% in 2023, against the 5.1% median projected for 2023 by all 19 Fed officials. “Any sign of slow progress that keeps inflation elevated for longer will warrant, in my view, taking the policy rate potentially much higher.”

At the December meeting, the Fed lifted the target federal funds rate by 0.5 percentage points to a range between 4.25% and 4.50%.

Cognizant Of Risks

If there was a rough consensus about the coming year, the projections for next year differ dramatically, with one Fed official seeing the policy rate remaining at 5.625%, one seeing it reduced to 3.125%, and no more than seven officials in unison on any particular rate in an economy that still may be flirting with or muddling through a recession.

With its descriptions of conflicting points of view and the rough sizes of groups of policymakers giving them, the minutes could show the Fed’s internal deliberations going into a new phase where risks to employment and economic growth are given more standing, and a wider range of opinions aired about the tradeoffs needed to continue easing inflation.

The Fed “seems united on getting policy above 5% but is quite split on exit strategy; how long to hold and how deeply and rapidly to ease on the other side,” Derek Tang, economist at LH Meyer, wrote on Tuesday.

The minutes could also help identify how much sentiment there is to slow the pace of upcoming rate hikes to 0.25 percentage points as of the Jan. 31-Feb. 1 meeting, a way to balance the competing risks the Fed may encounter in 2023 if inflation continues reducing and the economy continues to weaken.

The Fed used three-quarters-of-a-percentage-point increases for much of last year, but pruned that to a half-percentage-point hike in December and signaled it may reduce the pace even further.

Though Fed Chair Jerome Powell in December remained insistent the central bank will do what it takes to curb inflation, he also said officials are aware of the risks of overdoing it – something Fed staff also have started to emphasize.

In the minutes for the Nov. 1-2 meeting, Fed staff put roughly even odds on a recession in 2023, and new research late in December cautioned that with the world’s major central banks hiking rates simultaneously the combined impact may be stronger than expected as policy in one country influences currency values, bond yields, and trade patterns in another.

Fed economists Dario Caldara, Albert Queralto, and Francesco Ferrante wrote:

“It is especially challenging to estimate spillovers, and there are concerns that policymakers may underestimate them. In such a case, there is a risk of overtightening that central banks need to be, and we believe are, cognizant of.”