According to minutes released on Wednesday (May 24, 2023), the Federal Reserve’s officials were split over how to proceed with interest rates at their most recent meeting; some saw the need for further hikes while others anticipated a slowdown in growth to eliminate the need to tighten further.
Even though the unanimous decision to raise the Fed’s benchmark rate by a quarter percentage point was made, there was disagreement over the best course of action, with a lean toward less aggressive policy, according to the meeting report.
At the end, the rate-setting Federal Open Market Committee voted to remove a key phrase from its post-meeting statement that had indicated “additional policy firming may be appropriate.”
The Fed now seems to be heading toward a more data-dependent strategy, in which a variety of factors will determine whether the rate-hike cycle continues.
“Participants generally expressed uncertainty about how much more policy tightening may be appropriate,” the minutes said. “Many participants focused on the need to retain optionality after this meeting.”
Essentially, the debate came down to two scenarios.
One that was advocated by “some” members judged that progress in reducing inflation was “unacceptably slow” and would necessitate further hikes. The other, backed by “several” FOMC members, saw slowing economic growth in which “further policy firming after this meeting may not be necessary.”
The minutes do not identify individual members nor do they quantify “some” or “several” with specific numbers. However, in Fed parlance, “some” is thought to be more than “several.” The minutes noted that members concurred inflation is “substantially elevated” relative to the central bank’s goal.
‘Closely monitoring incoming information’
While the future expectations differed, there appeared to be strong agreement that a path in which the Fed has hiked rates 10 times for a total of 5 percentage points since March 2022 is no longer as certain.
“In light of the prominent risks to the Committee’s objectives with respect to both maximum employment and price stability, participants generally noted the importance of closely monitoring incoming information and its implications for the economic outlook,” the document said.
I do not expect the data coming in over the next couple of months will make it clear that we have reached the terminal rate. And I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2% objective. But whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks.
Governor Christopher Waller
Officials from the FOMC also took some time to talk about the banking industry’s issues, which have led to the closure of numerous medium-sized institutions. In accordance with the minutes, members are prepared to deploy their resources to ensure that the financial system has enough liquidity to meet its needs.
At the March meeting, Fed economists had noted that the expected credit contraction from the banking stresses likely would tip the economy into recession.
They repeated that assertion at the May meeting and said the contraction could start in the fourth quarter. They noted that if the credit tightness abated that would be an upside risk for economic growth. The minutes noted that the scenario for less impact from banking is “viewed as only a little less likely than the baseline.”
The minutes also reflect some discussion on the talks to raise the national debt ceiling.
“Many participants mentioned that it is essential that the debt limit be raised in a timely manner to avoid the risk of severely adverse dislocations in the financial system and the broader economy,” the summary stated.
Markets betting May was last hike
Release of the minutes comes amid disparate public statements from officials on where the Fed should go from here.
Markets expect that the May rate increase will be the last of this cycle, and that the Fed could reduce rates by about a quarter percentage point before the end of the year, according to futures market pricing. That expectation comes with the assumption that the economy will slow and perhaps tip into recession while inflation comes down closer to the Fed’s 2% target.
However, virtually all officials have expressed skepticism if not outright dismissiveness toward the likelihood of a cut this year.
Most recently, Governor Christopher Waller said in a speech Wednesday that while the data hasn’t presented a clear case for the June rate decision, he’s inclined to think that more hikes will be needed to bring down stubbornly high inflation.
“I do not expect the data coming in over the next couple of months will make it clear that we have reached the terminal rate,” Waller said, referring to the end point for hiking. “And I do not support stopping rate hikes unless we get clear evidence that inflation is moving down towards our 2% objective. But whether we should hike or skip at the June meeting will depend on how the data come in over the next three weeks.”
Chair Jerome Powell weighed in last week, providing little indication he ’s thinking about rate cuts though he said that the banking issues could negate the need for increases.
Economic reports have shown that inflation is tracking lower though it remains well above the central bank’s goals. The Fed’s preferred personal consumption expenditures index excluding food and energy showed an increase in core inflation of 4.6% on an annual basis in March, a level it has been at for months.
A bustling labor market has kept the pressure on prices, with a 3.4% unemployment rate that ties a low going back to the 1950s. Wages have been rising as well, up 4.4% from a year ago in April, and a research paper this week from former Fed Chairman Ben Bernanke said the trend represents the next phase in the inflation fight for his former colleagues.
In May, purchasing managers’ indices from S&P Global reached a 13-month high, showing that while there are now few indicators of a recession, one could develop later in the year. The Atlanta Fed’s GDPNow tracker of economic data shows growth at a 2.9% annualized pace in the second quarter.
