Key takeaways from the FOMC June meeting minute
When the Fed minutes were announced late on Wednesday, the question was never about whether but how much. The debate was more on whether the Fed would hike rates by 50 bps or 75 bps in the July FOMC meeting. Since March, Fed has hiked rates by 150 bps and it looks most likely to repeat the 75 bps rate hike in the July meet too. However, the rate hikes are likely to taper to 50 bps in September and probably to 25 bps after that. However, the FOMC minutes still hint at a target of 3.50% interest rates by end of the year 2022.
An interesting question ahead of the Fed minutes was how much beyond the neutral rate would the Fed go. The Fed neutral rate currently stands at 2.5%, which is the rate up to which inflation can be regulated, without impacting GDP growth in a negative manner. Beyond that level, GDP is likely to see sharp hits. Remember, the US yield curve has already acquired a negative slope, hinting at a strong prospect of recession. However, the Fed is intent on traversing nothing less than 90 bps above the neutral rate to 3.40% in CY 2022.
How we see the rates panning out in 2022 and 2023?
The CME Fedwatch has assigned a 91% probability of 75 bps rate hike in July 2022 FOMC meet and an 80% probability of another 50 bps rate hike in September 2022. That would effectively mean that Fed rates would be at 2.75% to 3.00% by September 2022, leaving the Fed with room for another 50 bps rate hike between November and December 2022. That would be nearly 100 bps above the neutral rate of 2.50%, likely by end of 2022.
OK, but what happens after that. There is some long end toning down here. For example, the consensual long term rate forecast has fallen from a worst case scenario of 4.25% to 3.75%. This also includes the possibility that if push comes to shove and growth gets adversely affected, then Fed could even start cutting rates in 2023. The Fedwatch is now showing increasingly concerns that by 2023, growth would again prevail over inflation.
5 important points we gathered from the Fed minutes
The FOMC minutes come at a time when the US economy is caught in the horns of a dilemma. It has to choose between more inflation and more growth. Things would be OK on inflation control, as long as recession does not start pinching. Here is what we gather.
a) The short term stance of the Fed is still very hawkish. It is prepared to hike rates by 50 bps or 75 bps in the July and September 2022 meetings and has said it will be more restrictive if required. Fed can go 90 bps to 100 bps beyond the neutral rate in 2022.
b) FOMC has ruled out any change in its monetary stance unless inflation falls to the 2% levels. However, some of that distance may have already been covered in the commodity price meltdown in the last few days. PCE inflation, the measure that the Fed uses, is likely to remain elevated at around 5.3% for the current year.
c) For the FOMC, it is not just about managing inflation, but also about managing inflation expectations. They have to assure people that the Fed is dead serious about fighting inflation down to 2%. The worry is; real GDP growth is already negative for 2 quarters.
d) The sustained hawkish policy of the Fed, even at the expense of growth, has created a rather piquant situation wherein the yield curve has inverted with the 2 year bond yields higher than the 10-year yields. Short term inflation fight, is going to impair growth.
e) While the Fed continues to hold its stance that it will not compromise on inflation at any cost, the market data is indicating that the Fed may soon undergo a change of heart. While it may remain hawkish in 2022, it could see a change of heart in 2023.
The global situation is a lot more intriguing. While the US and UK are sold on to the hawkishness story, there are few other takers. EU, Japan and China are still playing the loosening game. India is relatively neutral. For now, the RBI is only undoing the dovishness and easy money policies of the pandemic. The test for the RBI would be, what it will do once that unwinding is done and dusted.
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