The Federal Reserve plans to move forward with multiple 50-basis-point interest rate hikes to fight inflation, minutes from the May Federal Open Market Committee (FOMC) policy meeting revealed Wednesday.
According to the minutes, Committee members stated that the first-quarter economic construction offered “little signal about subsequent growth,” adding that they think real GDP would expand “solidly” in the second quarter.
Inflation risks still captured the Fed’s attention as officials highlighted that they have been “highly attentive” to the issue. FOMC members averred that the central bank needs to shift monetary policy toward a more “restrictive” position “depending on the evolving economic outlook and the risks to the outlook.”
Minutes noted that the institution is concerned that the Ukraine-Russia military conflict and China’s COVID lockdowns pose “heightened risks” to the economic recovery. The FOMC concurred that there will be challenges to restoring price stability and facilitating a strong labor market. These developments and their “implications for the U.S. economy were highly uncertain.”
FOMC participants acknowledged the financial strain that households are experiencing due to 40-year high inflation.
“Participants observed that inflation continued to run well above the Committee’s longer-run goal and that inflation pressures were evident in a broad array of goods and services,” the minutes stated. “Various participants remarked on the hardship caused by elevated inflation and heightened inflation uncertainty—including by eroding American families’ real incomes and wealth and by making it more difficult for businesses to make production and investment plans. They also pointed out that high inflation could impede the achievement of maximum employment on a sustained basis.”
Ultimately, according to the Fed policymakers, the U.S. economy is “very strong,” the labor market is “extremely tight,” and inflation is “very high.”
Most meeting participants endorsed 50-basis-point rate hikes at the next two meetings. They also supported efforts to trim the central bank’s $9 trillion balance sheet, and others noted it would be appropriate to think about sales of mortgage-backed securities.
The Fed had agreed to cut the balance sheet by trimming $47.5 billion per month for the first three months, including $30 billion for Treasury securities and debt and agency mortgage-backed securities. This would then be increased to $95 billion per month.
“To ensure a smooth transition, the Committee intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves,” the minutes noted. “Once balance sheet runoff has ceased, reserve balances will likely continue to decline for a time, reflecting growth in other Federal Reserve liabilities, until the Committee judges that reserve balances are at an ample level.”
The U.S. financial markets were quiet after the minutes were published. The Dow Jones Industrial Average was down 0.23 percent, the S&P 500 rose 0.18 percent, and the Nasdaq Composite Index jumped 0.68 percent.
The U.S. Dollar Index (DXY), which measures the greenback against a basket of currencies, pared its gains to 0.27 percent to 102.14. The Treasury market was mixed, with the benchmark 10-year yield down 1.5 basis points to 2.745 percent.
What Experts, the Fed Are Saying
Prior to the release of the FOMC minutes, investors had been monitoring several subjects, says Thomas Urano, the managing partner at Sage Advisory.
According to Urano, the market was monitoring any mentions of tightening financial conditions, recognition that the market has been doing the central bank’s “heavy lifting,” and discussions of a potential rate hike pause later this year amid a global economic slowdown.
Regardless of what was revealed in the minutes, Bryce Doty, the senior portfolio manager at Sit Investment Associates does not believe traders have much faith in today’s economic environment.
“Investors are sensing this economic train wreck and it’s no surprise many are fleeing the stock market,” he wrote in a research note.
Doty argues that the head of the Federal Reserve System is making a case for the institution to pursue policies that shrink economic activity. Powell recently told American Public Media’s “Marketplace” that accomplishing a soft landing—fighting inflation, supporting growth, and keeping labor intact—might be out of the body’s control.
“The question whether we can execute a soft landing or not—it may actually depend on factors that we don’t control,” the Fed chair said. “There are huge events, geopolitical events going on around the world, that are going to play a very important role in the economy in the next year or so.”
Atlanta Fed Bank President Raphael Bostic urged the central bank to be more cautious moving forward.
“Given the very high level of inflation, some might be surprised by my injecting some caution here. But remember this: even firetrucks with sirens blaring slow down at intersections lest they cause further preventable trouble,” Bostic opined in an essay published on the regional central bank’s website.
Due to the growing number of uncertainties, from the military conflict in Eastern Europe to supply constraints, Bostic urged monetary policymakers to “be mindful of those uncertainties and proceed carefully in tightening policy.”
An increasing number of officials are split on the size of rate hikes throughout the rest of 2022. Some want to sustain the 50-basis-point rate hikes, and others assert that the path to a neutral rate should be slowed down to a quarter-point hike.
Cleveland Fed President Loretta Mester has endorsed accelerating rate increases if inflation is coming down in any meaningful way. She told Yahoo Finance at the 2022 Financial Markets Conference that half-point hikes at the next two meetings “makes sense.”
“We have to get inflation under control. And that means moving the interest rate up. We have to move it up at a pace that will get that inflation under control,” she said without ruling out a 75-basis-point jump in the benchmark fed funds rate.
Speaking in an interview with Fox Business on Friday, St. Louis Fed Bank President James Bullard reiterated his position that the central bank needs to get to 3.5 percent by the year’s end.
“We have to get inflation under control, and I think we have a good plan to do so,” Bullard said. “Fifty basis points is a good plan for now. As always, we have to pay attention to incoming data on the economy and on inflation. You can never make ironclad promises in this business, but we will see how this goes.”
If the Fed front-loads interest rate increases and inflation is finally brought under control, the FOMC can start trimming the benchmark policy rate again, Bullard added.
In his interview with Fox Business, Bullard noted that a recession would only transpire if “there’s some really large shock,” but he does not see one forming in the near term.
The interest-rate futures market had been penciling in a rate cut in the second half of 2023, suggesting that investors believe the Fed would attempt to respond to economic weakness if it can successfully grapple with inflation.
Despite all of the Fed’s efforts, Doty contends that the central bank will exacerbate the many underlying issues in the post-pandemic U.S. economy, including more shortages and higher prices.
“The Fed will likely get half of its wish and push the country into a recession but without meaningfully eliminating shortages and most likely making them worse,” he stated. “Unless, of course, our bodies no longer need as much nourishment to survive and so forth.”
According to the CME FedWatch Tool, the market is anticipating two more 50-basis-point rate hikes at the June and July FOMC policy meetings. But a growing number of investors forecast that tightening will slow to a quarter-point.