– Rate Hikes Would Be At ‘Faster Pace” if Inflation Doesn’t Moderate
– Appropriate Pace of Rate Hikes Will Be Reassessed “At Each Meeting”
By Steven K. Beckner
(MaceNews) – Federal Reserve officials saw a need to start withdrawing monetary stimulus to curb inflation within the context of a “strong” labor market at their Jan. 25-26 Federal Open Market Committee meeting, but did not lean toward aggressive or early credit tightening, minutes of the meeting released Wednesday show.
The minutes do say that most FOMC participants thought a “faster pace” of rate hikes would be warranted if inflation did not moderate. They do not give a time frame for making that determination, but say the amount would need to be reassessed “at each meeting.”
It was agreed that the Fed should end asset purchases “soon” and that balance sheet reduction should being “later this year,” with “many’ favoring sales of agency mortgage backed securities, with the proceeds going into purchases of Treasury securities.
There was clearly a heightened sense of concern about inflation at the last FOMC meeting, but not the same degree of urgency in confronting it as found in financial markets more recently. The minutes also suggest some dissension over how aggressively to withdraw monetary stimulus.
Some FOMC participants warned financial conditions could “tighten unduly” if the Fed were to raise rates too fast.
Nor do the minutes suggest great urgency about reducing the Fed’s nearly $9 trillion balance sheet.
Although the FOMC left monetary policy unchanged on Jan. 26, it made significant changes in its policy statement. Concluding that it had achieved both its inflation and maximum employment goals, the FOMC declared it “expects it will soon be appropriate to raise the target range for the federal funds rate” – a strong signal that the FOMC will lift off from its zero to 25 basis point target range after two years at its March 15-16 meeting.
The FOMC also announced it will end its asset purchases (“quantitative easing”) in early March, and it released a preliminary set of “Principles for Reducing the Size of the Federal Reserve’s Balance Sheet” in preparation for trimming the Fed’s $8.9 trillion balance sheet.
Since the January meeting, some Fed officials have been outspoken in favor of early and aggressive monetary tightening, including a 50 basis point funds rate hike on March 16 and an early start to “quantitative tightening.”
Much has changed since the FOMC last met, and speculation about more aggressive monetary tightening has intensified by evidence of further deterioration in the inflation picture. The consumer price index rose a worse than expected 7.5% compared to a year ago in January (6.0% core). The producer price index pointed to even worse inflation in the pipeline, rising 9.7% year-over-year ((6.9% core). On the wage front, average hourly earnings climbed 5.7% from a year ago last month. That was also more than expected and up from December’s 4.7% pace.
Such data have led many Fed watchers to believe the FOMC will lift off from the zero lower bound with an initial 50 basis point rate hike.
But there is little indication of support for that kind of near-unprecedented rate action in the minutes. Rather they suggest a more “deliberate” approach, in line with what Kansas City Federal Reserve Bank President Esther George has suggested.
The FOMC’s discussions seem to have been much more focused on inflation than in prior meetings.
“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 …,” the minute say, citing such factors as “the zero-tolerance COVID-19 policy in China that had the potential to further disrupt supply chains, the possibility of geopolitical turmoil that could cause increases in global energy prices or exacerbate global supply shortages, a worsening of the pandemic, persistent real wage growth in excess of productivity growth that
could trigger inflationary wage–price dynamics, or the possibility that longer-term inflation expectations could become unanchored.”
Against that backdrop, as well as the Committee’s conclusion that “maximum employment” had largely been achieved, Fed officials agreed it was OK to leave the funds rate unchanged for the time being but that “it would soon be appropriate to raise the target range.”
Also, “in light of elevated inflation pressures and the strong labor market, participants continued to judge that the Committee’s net asset purchases should be concluded soon,” the minutes say. Most preferred to keep to the schedule announced in December, which would bring purchases to an end in early March.
Only “a couple” of participants wanted to end asset purchases sooner “to send an even stronger signal that the Committee was committed to bringing down inflation.”
The minutes suggest the timing and pace of monetary firming will have to be very flexible and data dependent – subject to change, depending especially on how inflation behaves.
Most thought rate hikes should come “at a faster pace” than in 2015, when the FOMC last left the zero lower bound, because “there was a much stronger outlook for growth in
economic activity, substantially higher inflation, and a notably tighter labor market.”
But the minutes leave open the question of whether rates will be raised faster than anticipated in December, when the median projection was for three 25 basis point rate hikes in 2022.
“(P)articipants emphasized that the appropriate path of policy would depend on economic and
financial developments and their implications for the outlook and the risks around the outlook, and they will be updating their assessments of the appropriate setting for the policy stance at each meeting.”
“Participants noted that the removal of policy accommodation in current circumstances depended on the timing and pace of both increases in the target range of the federal funds rate and
the reduction in the size of the Federal Reserve’s balance sheet,” the minutes continue.
They add, “a number of participants commented that conditions would likely warrant beginning
to reduce the size of the balance sheet sometime later this year.”
The officials allowed for a more rapid pace of rate hikes if inflation continues to worsen: “Most participants noted that, if inflation does not move down as they expect, it would be appropriate for the Committee to remove policy accommodation at a faster pace than they currently anticipate.”
However, “some participants commented on the risk that financial conditions mighttighten unduly in response to a rapid removal of policy accommodation.”
For the second straight meeting, the FOMC discussed balance sheet management, receiving another staff presentation on the subject and deciding to issue a broad set of “principles’ for balance sheet reduction.
But the minutes do not indicate a desire to rush into balance sheet reduction in describing the discussions after the staff presentation.
“While participants agreed that details on the timing and pace of balance sheet runoff
would be determined at upcoming meetings, participants generally noted that current economic and financial conditions would likely warrant a faster pace of balance sheet runoff than during the period of balance sheet reduction from 2017 to 2019,” they say.
“Participants observed that, in light of the current high level of the Federal Reserve’s
securities holdings, a significant reduction in the size of the balance sheet would likely be appropriate,” the minutes continue.
But “participants noted that the level of securities holdings consistent with implementing monetary policy efficiently and effectively in an ample reserves regime was uncertain and probably would remain so,” the minutes go on. “Consequently, market conditions would have to be monitored closely to determine the appropriate longer-run level of reserves and the size of the balance sheet.”
As put forth in the statement of principles, FOMC participants agreed the FOMC “should reduce the Federal Reserve’s securities holdings over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held in the SOMA” and that the System Open Market Account “should hold primarily Treasury securities in the longer run.”
In that regard, the minutes say “many participants commented that sales of agency MBS or reinvesting some portion of principal payments received from agency MBS into Treasury securities may be appropriate at some point in the future to enable suitable progress toward a longer-run SOMA portfolio composition consisting primarily of Treasury securities.”
While thinking it appropriate to make an early release of a set of principles, FOMC participants “also agreed that it was important for the Committee to retain the flexibility to adjust any of the details of its approach in light of changing economic and financial conditions.”
The statement of principles was seen as “an important guide in future deliberations on balance sheet reduction.”
“While no decisions regarding specific details for reducing the size of the balance sheet were made at this meeting, participants agreed to continue their discussions at upcoming meetings,” the minutes say.