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By: Rhona O'Connell, Head of Market Analysis
Fed Minutes: uncertainty over inflation and a hawkish shift
The November FOMC meeting was not one of those in which the Committee builds the dot plot matrix that shows their expectations for where interest rates will be at the end of each of the next few years. For completeness, this is the dot plot that was built in Summary of Economic Projections from the September meeting (the next one will be in the meeting of 14th-15th December).
So we had three Committee members seeing the fed funds target rate lower band up by 50 basis points next year and six with a 25-point hike. The outlook for 2023 was much more hawkish.
This note will highlight the differences in wording between the September and November Minutes. We précis the Staff’s background expectations, with the caveat of course that the progress of the containment or otherwise of the virus is a key variable. We finish with a quick assessment of the Committee’s shifting stance on inflationary forces.
The tone was clearly more hawkish this time around.
The key difference comes in the opening paragraph of the Staff’s discussion of financial markets and operations. In September the opening remarks noted that overall, financial conditions were little changed over the intermeeting period and remained highly accommodative, with implied forward inflation rates from TIPS increasing modestly. This time, “Sovereign yields rose sharply across many advanced economies with much of the increase concentrated in measures of inflation compensation. In the United States, the five-year measure of inflation compensation based on Treasury Inflation Protected Securities (TIPS) rose by around 45 basis points. Far forward measures of inflation compensation also rose, but by modest amounts”.
As far as market opinions are concerned, there was little comment in the September Minutes about inflationary expectations among market participants. This time it’s right up there in the first paragraph, with what looks like a balance between “transitory” and “persistent”; “In the Open Market Desk’s surveys of primary dealers and market participants, the median forecast for headline PCE inflation in 2021 was revised up notably. Median forecasts beyond 2021 move up by less, although the average of the probabilities reported by survey respondents placed on higher inflation outcomes at these horizons increased modestly”.
With respect to other central banks, in September the Staff noted comments on tapering, or plans for balance sheets once tapering was completed. This time the emphasis was much more on increases in policy-sensitive rates “across most advanced economies”.
In September, roughly half the respondents to surveys of primary dealers and market participants saw December as the most likely timing of the start of United States tapering; this time the expectation was focused on November, and “the market-implied path of the federal funds rate rose, implying an earlier date for raising the target range for the federal funds rate and a faster pace of rate hikes than was the case in September”, but opinion was more moderate than the market rates’ implications.
On the debt ceiling, the Staff noted that the short-term resolution in October raised the debt limit by $480Bn. The market is relatively sanguine that a resolution would be reached before the Treasury had to delay a payment (i.e. more or less default, which is politically unthinkable in the eyes of US legislators). Some market participants believe that the cash runs out as early as mid-December and “uncertainty about the debt ceiling resolution remained a source of concern in financial markets”.
Despite some slowing in Q3 GDP and supply chain bottlenecks lasting longer than previously expected, the Staff expect a sizeable gain in 2021 as a whole and a similar pace in 2022, supported by the continued reopening of the economy and the resolution of supply chain issues. The twelve-month change in PCE prices was expected to end the year well above 2% (and as we saw yesterday, the October core PCE was 4.5%). The staff continued to judge that those risks to the baseline projection for economic activity were skewed to the downside and that the risks around the inflation projection were skewed to the upside; and they are not discounting the risk of another sizeable wave in the virus along with the possibility of more severe and persistent supply issues.
The Committee, inter alia, directed the Desk to complete the monthly programme of $80Bn of Treasury and 40Bn mortgage-backed securities and to reduce them by $10Bn and $5Bn respectively; and to continue the necessary open market operations to ensure smooth functioning of the markets. This drops again in December, and we should expect that to continue until the programme is complete at the end of May, provided nothing happens to blow it off course. In fact the Statement does say that the Committee is prepared to change the pace of purchases if warranted by changed in the economic outlook.
The Committee also adjusted its stance on inflation, with a slightly more hawkish tone. In September, the wording was “Inflation is elevated, largely reflecting transitory factors.” This time: “[The Committee members] also concurred that it would be appropriate to convey less certainty about the path of inflation by noting that the factors driving elevated inflation “are expected to be transitory.” In order to provide additional information about these factors, members further decided that the post meeting statement would say that “supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.”
So the hawks are circling, but they're still quite high in the sky.
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