Fed: Minutes explain the distinctions regarding the decision to pause the rate in June

Fed officials were less united than the unanimous resolution at the June meeting suggested, as some supported raising interest rates, but complied with the decision not to change policy. Supporting the increase, officials cited tight labor markets and relatively few signs of inflation slowing towards the 2% target.

The Fed's decision last month was the latest slowdown in policy after officials' rates increased by 75 basis points four times in a row last year, the fastest in four decades. They started slowing that pace in December, and have increased by a quarter point in each of the first three meetings of this year. There seem to be a few key points to consider in the minutes.

If we take a look at the highlights of the Fed minutes;

·        Nearly all respondents agreed that keeping the target range for the federal funds rate between 5% and 5.25% is appropriate or acceptable.

·        Some participants stated at this meeting that they are in favor of increasing the target range for the federal funds rate by 25 basis points, or that they might support such a proposal.

·        Most officials pointed to the resilience of the US economy as an overall positive feature that has so far kept a recession at bay, but some elements of it – such as the persistently strong labor market – expressed concern about how long it would take to push inflation back to the Fed's 2% target.

·        The Fed's economic team expects a moderate recession later in the year, citing tightening bank loan conditions and already tight fiscal conditions. However, the team has previously argued that inflation is temporary, and this may explain why the Fed continues to tighten monetary policy despite the recession scenario.

·        The minutes mention "some" participants who think that the bank crisis may still have an impact. Similarly, there is a group that deals with commercial real estate (CRE). It is possible for these groups to overlap. However, the precise nature of their concerns has not been elaborated upon.

·        The frequency of words such as "inflation" in the minutes is higher than the frequency of words such as "stagnation" or "slowdown". This shows that inflation attracts more attention in the discussions. The impact of the war was voiced in May but not discussed in June.

The minutes shed light on how difficult it is for policymakers to make decisions. Even if they didn't change rates, nearly all officials said additional increases would likely be appropriate, and most stressed that post-meeting communication would be necessary to get that message across. The data provides more clarity to Fed watchers who are baffled by the decision to leave interest rates unchanged in the 5% to 5.25% target range, while also predicting further increases later this year.

While the headline reading of the personal consumption expenditures index, the Fed's preferred indicator for price changes, fell in May, the core benchmark showed that the underlying inflation may be slowing. PCE minus food and energy rose 4.6% year-on-year in May and has changed little since December. In the first phase of the tightening cycle, a bifurcation began to form between officials who almost agreed last year. While some officials now argue that the cooling in broad price indices indicates that the decline in inflation is effective, others say that small movements in core indicators reflect fundamental imbalances that need to be corrected. Economic forecasts for the June meeting continued to assume that the effects of further tightening in bank lending conditions due to already tight financial conditions would lead to a moderate recession to begin later this year, followed by a moderate recovery.

Federal Funds Target Rate – Upper Limit… Source: Bloomberg, Federal Reserve

The meeting left some Fed watchers and investors confused about the direction of the central bank, but in several public statements since then, Chairman Jerome Powell emphasized that many of his colleagues at the policy-making FOMC supported further rate hikes. Speaking last week, Powell said, "The vast majority of committee participants think it would be appropriate to raise interest rates two or more times by the end of the year."

Officials will receive two key economic reports ahead of the July 25-26 FOMC meeting: the June employment report on Friday and the consumer price readings for the same month on July 12. The main scenario priced in seems to be the interest rate hike in July. However, a weak headline, rapidly falling wages, a net negative revision on Friday or data pointing to weakening inflation could affect the deviation from this expected scenario. Just before the minutes were released, markets had a roughly 80% chance of a 25bp increase this month, and they didn't anticipate any further increases later in the year, according to federal funds futures data on Bloomberg.

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