Fed: Restrictive rates to apply, but calibration also required

Fed officials committed to raising interest rates to a restrictive level in the near-term and keeping inflation there to return them to their targets, according to the September 20-21 meeting minutes, but some said it would be important to calibrate increases to mitigate risks.

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

 Several respondents indicated that it would be important to adjust the pace of further policy tightening to mitigate the risk of significant adverse effects on the economic outlook, particularly in the current highly uncertain global economic and financial environment.

Many respondents stressed that the cost of taking too little action to reduce inflation likely outweighs the cost of taking too much action.

A few respondents observed that risks would become more bilateral as policy moved into restrictive territory, reflecting the emerging risk that the cumulative restraint on aggregate demand would exceed what is needed to bring inflation back to 2%.

Agreed that the Committee will help ensure that high inflation does not stabilize and inflation expectations do not remain stable by purposefully moving policy towards an appropriately restrictive stance.

Participants indicated that a period of below-trend real GDP growth would help reduce inflationary pressures and lay the groundwork for the Committee’s continued achievement of maximum employment and price stability targets.

Corporate bond spreads narrowed slightly on the net and remained roughly in the midpoints of their historical distributions. Yields on corporate bonds have risen significantly since the start of the year, reflecting increases in both policy rates and corporate bond spreads. Municipal bond spreads widened a touch over comparable Treasury futures yields.

Since the September FOMC meeting, Fedspeak showed the committee’s unusual alignment around the need to continue jumbo rate hikes despite heightened global economic and financial risks. The FOMC minutes provide further information on the committee’s rationale. Looking at the minutes, it appears that the committee has converged to push inflation back to the Fed’s 2% target, while some policymakers have been cautious as interest rates have reached restrictive territory.

In its September meeting, the Fed had increased the benchmark interest rate by 75 basis points for the third time in a row to combat persistent inflation pressures and raised the target funding range to the 3-3.25% range. Criticized by critics for being slow to respond to increasing price pressures, the Fed launched its most aggressive tightening campaign since the 1980s. Starting from near-zero rates in March, it rose 300 basis points, signaling more to come. On the pace of rate hikes: There is a broad perception in the Committee that financial conditions are not tight enough to warrant slowing the rate of rate hikes at 75 basis points per meeting. Some echo concerns along the lines of “something might break” if the pace continues, but a slightly larger group sees a more substantial risk that financial conditions will ease if the Fed slows the pace of tightening.

Fed officials expect to raise rates to 4.4% by the end of the year and to 4.6% in 2023, according to economic forecasts released at the last meeting. This has an economic cost: higher borrowing costs are expected to slow growth to 1.2% next year and push the unemployment rate to 4.4%. Unemployment rate was 3.5% in September. Employers added 263,000 jobs in September, and the latest consumer inflation report showed prices rose 8.3% in the 12 months through August. The September consumer price index, due to be released on Thursday, is still expected to show rapid progress of 8.1% and the core inflation rate is expected to return to its highest level in four decades. The September jobs report was one of the two main economic indicators the FOMC will take ahead of its November meeting, making it clear for the Fed to raise 75 basis points for the fourth consecutive year. The September CPI report will also not give policymakers any reason to change course. Most members agree that real rates should reach 1.5%-2% by 2023. Differences in the terminal rate in the dot chart are mostly explained by various views on inflation forecasts.

Recent data and signals have strengthened claims that the Fed will raise rates again by 75 basis points next month, and November’s rise will likely be the last 75 basis points. On the other hand, there are many reasons for the Fed’s pivot scenario to remain in the background, and the general opinion will be shaped within the framework of the movement trend after the interest rate rises to a maximum within the 4.5-5% band. For the Fed’s policy tightening to come to an end, the wage-inflation spiral needs to be resolved and the factors reflecting it need to be alleviated. Because factors other than product cost also affect producer costs, and as a result, we continue to observe high inflation increases. The September minutes show that many members of the committee saw inflation solidifying. Although gasoline prices fell from mid-June to mid-September, it is problematic that monthly core inflation did not fall any faster. Some early signs that wages and prices are feeding off each other are also troubling. Rapidly rising borrowing costs have slowed housing activity, but other parts of the economy still show elastic demand.

So there are various views on what inflation will look like in the coming year. While some believe that easing supply bottlenecks will push inflation down rapidly, others think demand factors are keeping inflation above the Fed’s price target through 2024. Meanwhile, there are more frequent warnings that the Fed is over tightening. Some economists argue that the Fed should slow the pace of rate hikes as long-term inflation expectations stabilize, supply chain pressures ease, and a strong dollar cheapens imports. These are factors that can be heavily linked to external developments, where the real asymmetry seems to be the strengthening of the dollar.

When finance ministers and central bankers gather in Washington this week for the World Bank-IMF meetings, many may argue that the rest of the world can’t afford any more Fed hikes. If we take into account that the strengthening of the dollar will also create problems for many import-intensive countries, global growth will actually slow down more deeply with the steps taken by the Fed and other central banks that follow it as if there is a peg, regardless of any extra criteria. However, recent Fed statements made it clear that domestic concerns are the primary consideration for US monetary policy.

Kaynak: Tera Yatırım-Enver Erkan
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