MFN - FOMC minutes: Ongoing interest rate increases to be expected

Stefan Gerlach

The minutes from the Federal Open Market Committee (FOMC) meeting that took place on 31 January – 1 February and which were released on 22 February, show that FOMC members felt that a series of interest rate increases will be necessary to lower inflation to target.

Nevertheless, committee members did note that higher interest rates already had started to moderate inflation pressures by lowering the most interest-rate sensitive parts of spending, particularly that on housing. Some members also felt that the outlook for economic activity had shifted with a somewhat higher risk of below par growth. The risk of a recession later in the year was seen as remaining elevated.

Labour markets continue to be very tight, but members saw some tentative signs that the supply-demand imbalance was improving. Inflation was seen as “unacceptably” high. While sharp increases in the prices of housing services have been a major driver of inflation recently, FOMC members expect price increases in this market to moderate later in the year as rents on new leases have been stabilising.

The decision to raise the target range for the federal funds rate by 0.25% – that is, by a smaller amount than the 0.5% steps taken previously – to 4.50-4.75% was unanimous. Slowing the pace of interest rate increases would allow the Fed to better judge the effects of the substantial tightening of policy so far. FOMC members also agreed that additional increases at future meetings would be appropriate.

There was also unanimity about continuing the process of shrinking the Fed’s balance sheet.

Market interest rate expectations have in recent weeks been revised upward as several new data releases on inflation, employment and retail sales have indicated that the US economy is still running hot. The FOMC minutes fit that pattern and encouraged markets to price in higher interest rates that stay there for longer than previously expected.

The figure below (which focuses on the June, September and December meetings at which the FOMC will release its economic projections) shows that markets attach a 73% probability to another 0.25% increase in interest rates at the FOMC’s March meeting to the range 4.75-5% (and a 27% probability of a 0.50% increase). Furthermore, from the June meeting onward, interest rates are expected to be 0.75% higher than now and to remain at that level for the rest of the year. (Detailed probabilities are provided in the table in the Appendix.)

While some commentators have discussed the possibility of a 0.5% increase at an upcoming meeting, a large change seems unlikely since the FOMC has just emphasised the advantages of smaller steps and has noted that the lagged impact of last year’s rate increases has not yet been fully felt. Nonetheless, the much anticipated ‘pivot’ does not seem imminent. While the Fed is always dependent on incoming data, the market is currently highly sensitive to the macro situation with the result that rate expectations are prone to large and rapid swings. This is likely to persist until the outlook for the US economy becomes clearer.

Source: CME FedWatch Tool. Data as of 25 February 2023, probabilities less than 1% set to zero.

Source: CME FedWatch Tool. Data as of 25 February 2023, probabilities less than 1% set to zero.

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