Fed minutes show members unhappy with price monster

18 Aug 2022 , 09:18 AM

Since the Fed began its hawkish approach in March, there have been 4 rate hikes totalling 225 bps up to the July meet. On 17th August, the minutes of the FOMC meet concluded on 27th July were released. The one theme that comes out from the minutes is that the members of the FOMC are unhappy with the fall in inflation. Of course, this does not include the 60 bps fall in July, but that is unlikely to have left the members too impressed.

Out of the 225 bps rate hike in 2022, a total of 150 bps hike was done in just 2 tranches in June and July. That shows the extent of front loading that the Fed is prepared to do. Fed rates are now in the range of 2.25% to 2.50% and is already in neutral zone. Beyond this level, rate hikes would curb inflation and output with the same ferocity. It is going to be a much tougher trade-off for the Fed from here on.

However, there is some hope in the language of the Fed minutes. While the Fed may not relent on its inflation fight in 2022, the pace of rate hikes may taper. In 1981, when inflation was at current levels, the Fed rates were in double digits. Today, the Fed rates are around 600 bps below the average rate of inflation. That is what the Fed wants to rectify.

Peak rate expectations stay at 3.75% for now

The CME Fedwatch table below captures the implied probabilities. Rates have already risen from the range of 0.00%-0.25% to the range of 2.25%-2.50% between March 2022 and July 2022. Interestingly, FOMC members expect the rate hikes to be largely done and dusted by the end of 2022. That will give the Fed enough time and leeway to undertake corrective action, if required. Here are the implied Fed rate scenarios over next 8 meetings.

Fed Meet	275-300	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525
Sep-22	63.5%	36.5%	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil
Nov-22	Nil	30.1%	50.7%	19.2%	Nil	Nil	Nil	Nil	Nil	Nil
Dec-22	Nil	5.0%	33.5%	45.5%	16.0%	Nil	Nil	Nil	Nil	Nil
Feb-23	Nil	3.2%	23.5%	41.3%	26.3%	5.6%	Nil	Nil	Nil	Nil
Mar-23	Nil	2.2%	17.2%	35.8%	31.0%	12.0%	1.7%	Nil	Nil	Nil
May-23	0.1%	3.0%	18.2%	35.5%	29.9%	11.5%	1.6%	Nil	Nil	Nil
Jun-23	0.8%	6.7%	22.2%	34.1%	25.7%	9.3%	1.3%	Nil	Nil	Nil
Jul-23	2.4%	10.2%	25.0%	32.2%	21.8%	7.3%	1.0%	Nil	Nil	Nil

Data source: CME Fedwatch
 
Apart from the routine hawkishness, some interesting trends emerge.

• Between the Fed meet and the minutes, the probabilities of steeper rate hikes have gone up. The consensus for 2022 has gone up from 100 bps more to 125 bps more.
• That means, with rates already in the range of 2.25%-2.50%, the markets are betting on rates to touch the range of 3.50% to 3.75% by the end of 2022.
• Rate hikes for the rest of 2022 will be of lower intensity compared to June and July. That is an obvious inference, considering the US is already in neutral rate zone.
• The consensus estimate of Fed rate for 2023 is 4%. That leaves just about 25 bps of rate hikes in the whole of 2023, with enough room for corrective action if necessary.
• Fed minutes have stuck to their eventual inflation target of 2% and will not relent on rate hikes till there is substantial progress towards that target.

With the latest IMF projections indicating a clear slowdown in US growth, it remains to be seen how far the Fed can sustain its hawkishness.

It is likely that the monetary enthusiasm may get circumscribed by the gross fiscal realities. We have to wait and see.

What we gathered from the Minutes of the July 2022 FOMC meet

Here are some of the key takeaways emerging from the minutes of the July FOMC meeting, published on 17th August.

1. Members of the FOMC (Federal Open Markets Committee) agreed to stay hawkish on rates till inflation came down sharply and showed substantial progress towards the 2% target. The July 2022 inflation fell 60 bps but still hovers around 8.5%.
2. Fed has not provided any guidance for September but would prefer to be data driven. However, with another 125 bps rate hike likely in 2022, it looks like the Fed may go ahead with 50 bps rate hike in September 2022.
3. While the Fed rates in the range of 2.25% to 2.50% are already in neutral rate zone, majority of the members are insisting on quickly pulling the rates into restrictive zone, so that the impact on inflation would be immediate and perceptible.
4. The general consensus was that members were unhappy with the inflation stickiness. That is possibly due to the labour slack. While growth was a concern, the members feel the focus should be on killing inflation first, before worrying about growth.
5. While consumer inflation did taper to 8.5%, the PCE (private consumption expenditure) inflation which the Fed looks at, was up 100 bps to 6.8% in June. For now, the Fed will wait for the July PCE inflation, which will be announced in the end of August 2022.
6. There is also an issue of public perception. Currently, the Fed is seen as relentless in countering inflation and that has brought down inflation expectations. If the Fed is found wavering, expectations could again go up. Fed wants to avoid that.
7. A section of the FOMC does believe that the Fed may hit growth by overdoing rate hikes too fast. However, the markets despise entrenched inflation and the answer comes from the Dow Index, which has rallied 14% since the lows of Jun 2022.
8. There are 2 diverse sentiments coming from the minutes. There is consensus that at some point slowing aggregate demand would curb inflation. However, the FOMC is still not clear about how much is too much?
9. While there is still no consensus on the terminal rate of long term Fed rates, the Fedwatch seems to indicate a range of 3.75% to 4.00%. That is likely to be substantially front loaded in the current calendar year.

July inflation data shows the fall driven by oil. Food inflation is higher in July and core inflation is stable. Fed surely has a complex road ahead.

What do the Fed minutes mean for Indian economy

If the Fed has been hawkish, the RBI has not been neutral either. RBI has raised repo rates by 140 bps between May and July. That is almost at par with the Fed hawkishness. In addition, RBI has also hiked the base rate of SDF by 40 bps and the CRR by 50 bps. For now, the RBI has taken care of any real return edge that the US bonds may have.

How will the RBI react? In India, the inflation reaction has almost been immediate. For instance, CPI inflation has fallen 108 bps since April while WPI inflation has fallen by 270 bps since May. Fed going slow on rate hikes will be sentimentally positive for India. It reduces the dilemma for the RBI, as it can gradually direct its focus towards the growth engine.