FOMC Minutes: Sentiment for 50 bp Rate Hike Deferred Due to Ukraine Concerns

– Future 50 BP Hikes Apt To Be On The Table

– FOMC Made Ready For Balance Sheet Reduction With Expanded Caps

By Steven K. Beckner

(MaceNews) – Federal Reserve officials leaned heavily toward further increases in short-term interest rates at their mid-March Federal Open Market Committee meeting, but conditioned the size and pace of rate hikes on how an uncertain economic outlook unfolds, minutes of the meeting released Wednesday show.

The minutes of the Fed’s rate-setting body’s monetary policy discussions show considerable sentiment toward a larger rate hike than the one the FOMC approved, but show that concern about intensified geopolitical uncertainties and risks swayed the majority toward a more modest initial rate hike.

More aggressive moves will probably be considered at subsequent FOMC meetings, the minutes make clear.

The minutes also reveal considerable Committee support for a staff-recommended plan for shrinking the Fed’s $9 trillion balance sheet in the near future, using a similar strategy to that used in the 2017-19 “quantitative tightening” period, but with a stepped-up pace.

While conveying a willingness to move fairly aggressively to bring 40-year-high inflation under control, the minutes also reflect a sense of caution amid great uncertainty and downside risks stemming from Russia’s invasion of Ukraine.

The FOMC’s March 15-16 meeting marked its departure from a two-year stay at the zero lower bound, as the Committee raised the federal funds rate 25 basis points to a 25-50 basis point target range and stated it “anticipates that ongoing increases in the target range will be appropriate.” FOMC participants projected the funds rate would rise to a median 1.9% this year and to 2.8% next year – 40 basis points above the FOMC’s downwardly revised 2.4% “longer run” or “neutral” rate.

Though only St. Louis Federal Reserve Bank President James Bullard dissented in favor of an immediate 50 basis point rate hike, Cleveland Fed President Loretta Mester and others subsequently said the FOMC may need to raise the funds rate by that amount at coming meetings.

Chairman Jerome Powell told reporters each of the FOMC’s six remaining meetings this year will be “a live meeting” and said, “If we do conclude that it would be appropriate to move more quickly to remove accommodation then we’ll do so.”

Raising the funds rate by a larger amount is “certainly a possibility as we go through the year,” Powell added.

At the same time, though, various Fed officials have indicated since the meeting a desire to proceed cautiously and incrementally in tightening monetary policy. Most recently, Philadelphia Fed President Patrick Harker, an alternate voter on March 16, said Wednesday morning he “expect(s) a series of deliberate, methodical hikes as the year continues and the data evolve.”

Other officials have used similar language. Tuesday Governor Lael Brainard said, “The Committee will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting.” Last week, Kansas City Fed President Esther George called for a “steady, deliberate approach,” and Chicago Fed chief Charles Evans said the FOMC should be “cautious, humble, and nimble.”

Nevertheless, officials have been unanimous in saying the FOMC should move more aggressively

if inflation fails to moderate as hoped,

The minutes, which reflect discussions that occurred three weeks ago, largely presage recent policymakers’ comments.

While there was broad support for finally getting underway with policy normalization, there was considerable debate over how fast the FOMC should move.

“Many participants noted that—with inflation well above the Committee’s objective, inflationary risks to the upside, and the federal funds rate well below participants’ estimates of its longer-run level—they would have preferred a 50 basis point increase in the target range for the federal funds rate at this meeting,” the minutes say.

But “a number of these participants indicated, however, that, in light of greater near-term uncertainty associated with Russia’s invasion of Ukraine, they judged that a 25 basis point increase would be appropriate at this meeting.”

Though all but one voting member was against raising the funds rate by 50 basis points on March 16, the minutes suggest there is apt to be a lot of support for 50 basis point hikes subsequently: “Many participants noted that one or more 50 basis point increases in the target range could be appropriate at future meetings, particularly if inflation pressures remained elevated or intensified.”

The minutes also show a lot of sentiment toward moving quickly to neutral and perhaps beyond.

“Participants judged that it would be appropriate to move the stance of monetary policy toward a neutral posture expeditiously,” they say. “They also noted that, depending on economic and financial developments, a move to a tighter policy stance could be warranted.”

The minutes also show support for a “risk management” approach.

“(P)articipants noted that developments associated with Russia’s invasion of Ukraine posed heightened risks for both the United States and the global economy,” the minutes report. “Against this backdrop, all participants judged that risk management would be important in deciding upon the appropriate stance of monetary policy, and that policy also would need to be nimble in responding to incoming data and the evolving outlook.”

“In particular, all participants underscored the need to remain attentive to the risks of further upward pressure on inflation and longer-run inflation expectations,” the minutes add.

To shrink the Fed’s vast bond holdings, the staff recommended that the New York Fed’s Open Market Trading Desk allow a steadily increasing amount of maturing securities to run off instead of being rolled over or reinvested.

On March 16, the FOMC directed the Desk to “roll over at auction all principal payments from the Federal Reserve’s holdings of Treasury securities and reinvest all principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS.”

After a staff presentation on balance sheet reduction, the minutes say “all participants agreed that elevated inflation and tight labor market conditions warranted commencement of balance sheet runoff at a coming meeting, with a faster pace of decline in securities holdings than over the 2017–19 period.”

“Participants reaffirmed that the Federal Reserve’s securities holdings should be reduced over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the SOMA. Principal payments received from securities held in the SOMA would be reinvested to the extent they exceeded monthly caps.

“Several participants remarked that they would be comfortable with relatively high monthly caps or no caps,” the minutes continue., “Some other participants noted that monthly caps for Treasury securities should take into consideration potential risks to market functioning.”

FOMC participants “generally agreed that monthly caps of about $60 billion for Treasury securities and about $35 billion for agency MBS would likely be appropriate.”

The minutes say the officials also “generally agreed that the caps could be phased in over a period of three months or modestly longer if market conditions warrant.”

Participants discussed the approach toward implementing caps for Treasury securities and the role that the Federal Reserve’s holdings of Treasury bills might play in the Committee’s plan to reduce the size of the balance sheet, according to the minutes.

“Most participants judged that it would be appropriate to redeem coupon securities up to the cap amount each month and to redeem Treasury bills in months when Treasury coupon principal payments were below the cap,” they continue. “Under this approach, redemption of Treasury bills would typically bring the total amount of Treasury redemptions up to the monthly cap.”

There was not total agreement. The minutes say “several participants remarked that reducing the Federal Reserve’s Treasury bill holdings over time would be appropriate because Treasury bills are highly valued as safe and liquid assets by the private sector, and the Treasury could increase bill issuance to the public as SOMA bill holdings decline.”

“In addition, participants generally noted that maintaining large holdings of Treasury bills is not necessary under the Federal Reserve’s ample-reserves operating framework….”

It is evident from a reading of the minutes that Russia’s Feb. 24 invasion of Ukraine strongly affected the thinking of Fed officials at the March meeting. The primary concern going in was with inflation, which had been reported up 7.9% as measured by the consumer price index. The minutes also note that wages “were rising at their fastest pace in many years” – all this in the context of above-trend GDP growth and “very tight labor markets.”

However, the policy discussions were clearly thrown into a degree of turmoil owing to the war in Ukraine. Opinions varied on the degree of risk and the kinds of risks.

“Participants agreed that developments surrounding the Russian invasion of Ukraine, including the resulting sanctions, were adding to inflation pressures and posing upside risks to the inflation outlook,” say the minutes. “Participants noted that Russia and Ukraine were major suppliers of various commodities used in the production of energy, food, and some industrial inputs.”

“A continued cutoff of that supply from the world market would further push up prices for those commodities and, over time, lead to price increases in downstream industries.,” the minutes go on. “The invasion had also exacerbated the disruptions of supply chains.”

But there was also concern about the potential adverse impact of the war on growth and employment.

“Participants commented that, by leading to higher energy and food prices, weighing on consumer sentiment, and contributing to tighter financial conditions, the invasion also negatively affected the growth outlook,” say the minutes. “A few participants highlighted additional downside risks to growth associated with the war, such as the risk that a more protracted conflict than the public currently expects could lead to much tighter global financial conditions or other disruptions.”

The minutes say “a couple” of participants worried that “the increased uncertainty might lead businesses and consumers to reduce spending, though their business contacts currently were not seeing signs of such shifts or expecting a significant pullback in demand.

The FOMC ended up divided over which kinds of risks predominated.

“Several participants judged that the upside risk to inflation associated with the war appeared more significant than the downside risk to growth, as inflation was already high, the United States had a relatively low level of financial and trade exposure to Russia, and the U.S. economy was well positioned to absorb additional adverse demand shocks.”

Ultimately, it appears proponents of inflation risks as the biggest concern won the day. “In their discussion of risks to the outlook, participants agreed that uncertainty regarding the path of inflation was elevated and that risks to inflation were weighted to the upside….,” say the minutes.

However, they say, “Various participants noted downside risks to the outlook, including risks associated with the Russian invasion, a broad tightening in global financial conditions, and a prolonged rise in energy prices.”

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