Evening Brief – 08.16.23
The FOMC released the minutes of its July 25-26 meeting on Wednesday, and there was something in them for both the doves and hawks to feast on. The minutes revealed the debate over the appropriateness of keeping interest rates high even as job growth and inflation have cooled.
“Most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy.”
At the same time, downside risks to the health of the economy were also noted. “…participants considered the possibility that the cumulative tightening of monetary policy could lead to a sharper slowdown in the economy than expected, as well as the possibility that the effects of the tightening of bank credit conditions could prove more substantial than anticipated.”
On inflation, “..they stressed that inflation remained unacceptably high, and that further evidence would be required for them to be confident that inflation was clearly on a path toward the Committee’s 2 percent objective.”
Meanwhile, two of the 18 Fed officials wanted to keep rates unchanged. “They judged that maintaining the current degree of restrictiveness at this time would likely result in further progress toward the Committee’s goals while allowing the Committee time to further evaluate this progress.”
There is still a great deal of debate about future monetary policy. The markets remain wary of near-term hikes, while they’re pricing in rate cuts for next year.
The Fed funds market is still assigning a low probability of a quarter-point rate hike in September at 12%, but the November contract has nudged up to 37% from 26% last week.
But then the narrative turns. The markets are assigning a 60% chance of a quarter-point rate cut in May 2024 and an 80% probability in June.
The drop in inflation and the slowdown in employment growth support the FOMC doves’ case for holding rates steady. However, recent economic data indicating how resilient the economy has been has bolstered the hawks, with third-quarter GDP predictions increasing. The Atlanta Fed GDPNow estimate for the third quarter is 5.8%! Recent data reveals an economy that is accelerating rather than running below potential.
The next key event for policy-watchers will be the annual Jackson Hole Economic Symposium in Wyoming next week. Recall, at last year’s gathering Chair Jay Powell discussed the need for the economy to run below potential and about the Fed’s commitment to tackle inflation.
The Fed has already achieved significant success in bringing down inflation. However, with the economy proving far more resilient than many analysts projected and operating above potential, the Fed is struggling to find any slack.
This begs the question of whether the central bank will be confident in decreasing interest rates next year. The “no landing” scenario may not be acceptable to the Fed.