– 50-75 BP Hike in July Envisioned
– Policy Might Need to Become ‘Even More Restrictive” than Anticipated
By Steven K. Beckner
(MaceNews) – Federal Reserve officials tilted toward a more restrictive monetary policy at their mid-June Federal Open Market Committee meeting despite signs of a slowing economy, minutes released Wednesday reveal.
Not only did FOMC members vote for an immediate 75 basis point hike in the federal funds rate, with Kansas City Federal Reserve Bank President Esther George dissenting, Committee participants envisioned a further 50 or 75 basis point hike at their late July meeting and continued rate increases thereafter.
The minutes report that Fed officials recognized “an even more restrictive” monetary stance than then anticipated might become necessary to bring demand and supply back into balance to curb inflation that was running far above the Fed’s 2% target.
The FOMC made these credit tightening moves and plans even as they downgraded economic forecasts in a revised, quarterly Summary of Economic Projections. Fed officials faced a dilemma: while inflation risks had risen, risks to the economic outlook were seen “to the downside,” according to the minutes.
Despite signs of slower economic activity, the FOMC was focused primarily on a “significant” risk of higher inflation becoming “entrenched” in people’s expectations, the minutes show.
After getting the funds rate up to at least “neutral,” the minutes say policymakers expected to be “in good position” to decide how much more restrictive they might need to make monetary policy.
The FOMC raised the federal funds rate for a third straight meeting on June 15, this time by 75 basis points to a range of 1.50% to 1.75% — the largest rate hike since 1994. Afterward, Chair Jerome Powell told reporters the Fed will likely choose between a 50 or a 75 basis point hike at its July 26-27 meeting and said the Fed intends to move “expeditiously” to a “moderately restrictive” 3-3.5% by year’s end. The FOMC’s estimated “longer run” or “neutral” rate is 2.5%.
FOMC participants significantly elevated their funds rate expectations in the revised June SEP. They projected the funds rate will end this year at 3.4%%, up from 1.9% in the March SEP. By the end of next year, Fed officials saw the funds rate rising to 3.8%, up from 2.8% in March, before receding to 3.4% by the end of 2024.
Accompanying the anticipated faster pace of rate hikes was a gloomier set of economic forecasts. Officials saw GDP growth slowing to 1.7% this year and next, while the unemployment rate was projected to rise to 3.7% at the end 2022; to 3.9% at the end of 2023 and to 4.1% at the end of 2024.. By contrast, in March, officials projected GDP growth of 2.8% this year and 2.2% next year. They foresaw unemployment staying at 3.5% this year and next.
FOMC participants also revised their inflation projections up considerably in wake of larger than expected increases in prices and inflation expectations. They projected PCE inflation of 5.2% this year (4.3% core); 2.6% next year (2.7% core) and 2.2% in 2024 (2.3% core). By contrast, in March, officials forecast PCE inflation would decline from 4.3% this year (4.1% core) to 2.7% next year (2.6% core) and to 2.3% in 2024 (2.1% core).
The minutes suggest a strong commitment to continued monetary tightening to counter above-target inflation – and a hope that the economy would remain strong enough to weather the rate hikes.
“In discussing potential policy actions at upcoming meetings, participants continued to anticipate that ongoing increases in the target range for the federal funds rate would be appropriate to achieve the Committee’s objectives,” they say. “In particular, participants judged that an increase of 50 or 75 basis points would likely be appropriate at the next meeting.”
“Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist,” the minutes add.
But the minutes go on to suggest the FOMC would be feeling its way along after it gets the funds rate to neutral in deciding how much further to raise rates. “Participants noted that, with the federal funds rate expected to be near or above estimates of its longer-run level later this year, the Committee would then be well positioned to determine the appropriate pace of further policy firming and the extent to which economic developments warranted policy adjustments.”
“They also remarked that the pace of rate increases and the extent of future policy tightening would depend on the incoming data and the evolving outlook for the economy,” the minutes continue.”
Lately, some observers and critics have questioned whether the Fed has lost its credibility in protecting the purchasing power of the dollar, but the minutes make clear Fed officials don’t see it that way. “Many participants noted that the Committee’s credibility with regard to bringing inflation back to the 2% objective, together with previous communications, had been helpful in shifting market expectations of future policy and had already contributed to a notable tightening of financial conditions that would likely help reduce inflation pressures by restraining aggregate demand. Participants recognized that ongoing policy firming would be appropriate if economic conditions evolved as expected.
Further explaining the FOMC’s rationale for ratcheting up the funds rate at its steepest pace in nearly 30 years, the minutes say, “At the current juncture, with inflation remaining well above the Committee’s objective, participants remarked that moving to a restrictive stance of policy was required to meet the Committee’s legislative mandate to promote maximum employment and price stability.”
“In addition, such a stance would be appropriate from a risk management perspective because it would put the Committee in a better position to implement more restrictive policy if inflation came in higher than expected,” they continue.
The minutes sat “many participants judged that a significant risk now facing the Committee was that elevated inflation could become entrenched if the public began to question the resolve of the Committee to adjust the stance of policy as warranted.”
“On this matter, participants stressed that appropriate firming of monetary policy, together with clear and effective communications, would be essential in restoring price stability,” they add.
Fed officials were keenly aware of the added difficulty in making monetary policiy in the face of major geopolitical disruptions.
“Participants remarked that developments associated with Russia’s invasion of Ukraine, the COVID-related lockdowns in China, and other factors restraining supply conditions would affect the inflation outlook and that it would likely take some time for inflation to move down to the Committee’s 2% objective,” say the minutes.
“Participants also judged that maintaining a strong labor market during the process of bringing inflation down to 2% would depend on many factors affecting demand and supply,” they go on. “Participants recognized that policy firming could slow the pace of economic growth for a time, but they saw the return of inflation to 2% as critical to achieving maximum employment on a sustained basis.”
In preparation for the FOMC deliberations, the Fed staff revised its own economic outlook. The minutes say the staff forecast “implied a trajectory for real GDP that was lower than in the May projection.”
“The staff continued to project that GDP growth would rebound in the second quarter and remain solid over the remainder of the year,” the minutes continue. “However, monetary policy was assumed to be less accommodative than in the previous projection, and the recent and prospective tightening of financial conditions led the staff to reduce its GDP growth forecast for the second half of 2022 and for 2023.”
According to the staff projections, “the level of real GDP was still expected to remain well above potential over the projection period, though the gap was projected to narrow significantly this year and to narrow a little further next year.”
“Labor market conditions also were expected to remain very tight, albeit somewhat less so than in the previous projection,” the minutes add.
Meanwhile, the staff revised up its inflation projection for the second half of 2022 in response to “stronger-than-expected wage growth and the staff’s assessment that the boost to inflation from supply–demand imbalances in the economy, including in food and energy markets, would be more persistent than previously assumed.”
Following the staff’s lead, FOMC participants “revised down their projections of real GDP growth for this year, consistent with ongoing supply chain disruptions and tighter financial conditions.”
Because they believed “the imbalance between supply and demand across a wide range of product markets was contributing to upward pressure on inflation,” officials “saw an appropriate firming of monetary policy and associated tighter financial conditions as playing a central role in helping address this imbalance and in supporting the Federal Reserve’s goals of maximum employment and price stability.”
The minutes indicate FOMC participants were hopeful of getting outside assistance in curbing inflation. “An easing of supply bottlenecks, a further . in labor force participation, and the waning effects of pandemic-related fiscal policy support were cited as additional factors that could help reduce the supply–demand imbalances in the economy and therefore lower inflation over the next few years.”
However, the minutes added that “the timing and magnitude of these effects were uncertain.”
As of June 15, “participants saw little evidence to date of a substantial improvement in supply constraints, and some of them judged that the economic effects of these constraints were likely to persist longer than they had previously anticipated. Participants stressed the need to adjust the stance of policy in response to incoming information regarding the evolution of these and other factors.”
A worrisome labor market picture was a major part of FOMC discussions in June.
“Participants noted that the demand for labor continued to outstrip available supply across many parts of the economy,” say the minutes. “They observed that various indicators pointed to a very tight labor market.”
“These indicators included an unemployment rate near a 50-year low, job vacancies at historical highs, and elevated nominal wage growth,” the minutes go on. “Additionally, most business contacts had continued to report persistent wage pressures as well as difficulties in hiring and retaining workers….”
Although employment growth had moderated, it “remained robust,” even though it was observed that “labor force participation remained below its pre-pandemic level because of the unusually large number of retirements during the pandemic.” Officials “judged that the labor force participation rate was unlikely to move up considerably in the near term….”
There was optimism that labor markets would become less of a source of inflation concern, but not in the near term.
“While labor markets were anticipated to remain tight in the near term, participants expected labor demand and supply to come into better balance over time, helping to ease upward pressure on wages and prices,” say the minutes, which add that this was a further justification for aggressive rate hikes – even if it meant some increase in joblessness.
“As in the case of product markets, they anticipated that an appropriate firming of monetary policy would play a central role in helping address imbalances in the labor market,” they say. “With the tightness in labor markets anticipated to diminish over time, participants generally expected the unemployment rate to increase….”
It was hoped that the unemployment rate wouldn’t spike too much. “In light of the very high level of job vacancies, a number of participants judged that the expected moderation in labor demand relative to supply might primarily affect vacancies and have a less significant effect on the unemployment rate.”
There continued to be much greater concern with inflation – a trend that began with a policy pivot that began last Fall after an extended period of denial that high inflation was anything but “transitory.”
“Participants noted that inflation remained much too high and observed that it continued to run well above the Committee’s longer-run 2 percent objective, with total PCE prices having risen 6.3 percent over the 12 months ending in April,” say the minutes. “They also observed that the 12-month change in the CPI in May came in above expectations.”
“Participants were concerned that the May CPI release indicated that inflation pressures had yet to show signs of abating, and a number of them saw it as solidifying the view that inflation would be more persistent than they had previously anticipated…..,” the minutes add.
In belated recognition of the strength of wage-price pressures, the minutes say “participants judged that strong aggregate demand, together with supply constraints that had been larger and longer lasting than expected, continued to contribute to price pressures across a broad array of goods and services…..”
Reflecting Powell’s oft-repeated view of the underlying cause of high inflation, the minutes say “participants judged that strong aggregate demand, together with supply constraints that had been larger and longer lasting than expected, continued to contribute to price pressures across a broad array of goods and services.”
Echoing the Biden administration, a finger of blame was also pointed toward Russia in the minutes. Fed officials “They noted that the surge in prices of oil and other commodities associated with Russia’s invasion of Ukraine was boosting gasoline and food prices and putting additional upward pressure on inflation.””
But the minutes FOMC participants “expected that the appropriate firming of monetary policy and an eventual easing of supply and demand imbalances would bring inflation back down to levels roughly consistent with the Committee’s longer-run objectives by 2024 and keep longer-term inflation expectations well anchored.”
Despite officials’ continued belief in “well anchored” longer run inflation expectations, the minutes make clear that rising inflation expectations had become a bigger concern for the FOMC “Participants observed that some measures of inflation expectations had moved up recently, including the staff index of common inflation expectations and the expectations of inflation over the next 5 to 10 years provided in the Michigan survey.”
There seems to have been some confusion or conflicting interpretations of the various inflation expectations gauges.
“With respect to market-based measures, …a few participants noted that medium-term measures of inflation compensation fell over the intermeeting period and longer-term measures were unchanged,” the minutes say. “While measures of longer-term inflation expectations derived from surveys of households, professional forecasters, and market participants were generally judged to be broadly consistent with the Committee’s longer-run 2% inflation objective, many participants raised the concern that longer-run inflation expectations could be beginning to drift up to levels inconsistent with the 2% objective.”
“These participants noted that, if inflation expectations were to become unanchored, it would be more costly to bring inflation back down to the Committee’s objective,” the minutes add.
The minutes go on to say that “participants emphasized that they were highly attentive to inflation risks and were closely monitoring developments regarding both inflation and inflation expectations. Most agreed that risks to inflation were skewed to the upside and cited several such risks, including those associated with ongoing supply bottlenecks and rising energy and commodity prices.”
But there were also downside risks to consider. “Participants judged that uncertainty about economic growth over the next couple of years was elevated. In that context, a couple of them noted that GDP and gross domestic income had been giving conflicting signals recently regarding the pace of economic growth, making it challenging to determine the economy’s underlying momentum. Most participants assessed that the risks to the outlook for economic growth were skewed to the downside.”
“Downside risks included the possibility that a further tightening in financial conditions would have a larger negative effect on economic activity than anticipated as well as the possibilities that the Russian invasion of Ukraine and the COVID-related lockdowns in China would have larger-than-expected effects on economic growth,” the minutes add.