Almost all Federal Reserve policymakers backed a decision to further lower the pace of interest rate rises at the U.S. central bank’s last policy meeting, but also indicated that combating exceedingly high inflation would be the “key factor” in how much further rates need to increase.
In language that indicated a compromise between officials concerned about a weakening economy and those confident inflation would prove persistent, minutes from the Jan. 31-Feb. 1 meeting said policymakers decided rates would need to rise, but that the shift to smaller-sized increases would let them calibrate more closely with incoming data.
“Almost all participants agreed that it was appropriate to raise the target range of the federal funds rate 25 basis points,” with a majority of those saying that would allow the Fed better “determine the extent” of future hikes, said the minutes, which were released on Wednesday.
At the same time, “participants generally noted that upside risks to the inflation outlook remained a key factor shaping the policy outlook,” and that interest rates would need to increase and remain elevated “until inflation is clearly on a path to 2%.”
Only “a few” participants completely backed a larger half-percentage-point hike at the meeting, or said they “could have supported” it.
The Fed implemented a string of 75-basis-point and 50-basis-point rate increases last year in its battle to combat inflation that had soared to 40-year highs. The central bank’s policy rate is currently in the 4.50%-4.75% range.
The minutes’ reference to inflation risks as a “key” to policy implies latest data – showing less progress than expected – could mean a higher projected endpoint for the federal funds rate when policymakers announce new projections at the end of the March 21-22 meeting, said Omair Sharif, president of Inflation Insights.
Latest inflation data and upward revisions to earlier figures suggest the “upside risks to inflation” cited by policymakers in the minutes “are clearly much higher today than they were when the (Federal Open Market) Committee last met,” Sharif said, quoting the central bank’s policy-setting committee.
“The March dots will move higher,” with the median projected year-end policy rate perhaps sent up to as much as 5.6%, in contrast to the median 5.1% “dot plot” projection in December.
Bond yields surged following the issue of the minutes and the U.S. dollar rose against a basket of currencies. A modest rally in U.S. stocks dwindled.
The yield on the 2-year Treasury note, the government bond maturity most sensitive to Fed policy projections, surged about 4 basis points from its level before the issue to about 4.69%. The S&P 500 index (.SPX), rose about 0.25% before the minutes were released, and closed lower.
Traders of futures linked to the Fed policy rate added to bets on at least three further quarter-percentage-point rate increases at upcoming meetings, with contract pricing hinting at a top federal funds rate range of 5.25%-5.50%.
Recession Risk
The minutes showed the Fed steering towards a possible endpoint to its current rate hikes, at once reducing the pace in order to more carefully approach a possible stopping point while also leaving open just how high rates will eventually rise in the event inflation does not ease.
The readout of the meeting comprised in particular pointed back-and-forth references to sets of developments in the economy that caused a still huge degree of uncertainty about where things are heading.
While “some” participants saw an “elevated” possibility of a recession in the United States in 2023, and pointed to a fall in consumer spending at the end of last year, others pointed out that households continued to sit on excess savings and that some local governments had “sizeable budget surpluses” that could also help avoid a painful slowdown.
Business investment was “subdued” at the end of 2022. Still, “a couple” participants at the last Fed policy meeting said businesses “appeared more confident” that supply bottlenecks had been removed, and that the global economic environment was getting better and “could provide support to final demand in the United States.”
The minutes said the labor market continued hot, with businesses – at least outside the tech sector – “keen to retain workers even in the face of slowing demand,” a factor that would help bolster household incomes and spending.
‘Very Tight’ Labor Market
The Fed’s Feb. 1 policy statement said “ongoing increases” in rates would still be required, but diverted the focus from the pace of coming increases to their “extent,” a nod to the fact that policymakers believe they may be approaching a rate that is adequate to ensure continuous progress in slowing inflation.
Data since the last meeting has shown an economy continuing to expand and adding jobs at an unexpectedly fast pace, while making less progress back towards the Fed’s 2% inflation goal. Inflation by the central bank’s preferred measure was running in December at two and a half times the goal, with data for last month due to be issued on Friday.
Buy Crypto NowThe minutes indicated Fed officials are still attuned to the risk they may have to do more in order to keep inflation reducing, a hawkish tilt that may come into a more distinctive view when policymakers give new interest rate and economic projections at the meeting.
“Participants concurred that the Committee had made significant progress over the past year in moving toward a sufficiently restrictive stance of monetary policy,” the minutes said, describing an economy that continued to expand amid a tight labor market.
“Even so, participants agreed that, while there were signs that the cumulative effect of the Committee’s tightening of the stance of monetary policy had begun to moderate inflationary pressures, inflation remained well above the Committee’s longer-run goal of 2% and the labor market remained very tight.”
