On December 14, 2022, the Fed hiked by another 50bps. More interestingly, markets are pricing a further tightening of market conditions. Expectations for the trajectory of Fed rates moves has shifted hawkishly since the December FOMC statement.
It seems that markets have finally recalled to “not fight the Fed.”
As some of you might remember, financial conditions had eased before the FOMC. An easing of financial conditions is not what you want where you’re trying to tame inflation by hiking rates.
The Minutes of the FOMC from December 13-14, 2022 have now been released.
The Fed wasn’t a fan of the market rally prior to the December FOMC meeting
Fed officials were less than pleased with the sudden surge in stocks ahead of the meeting and the apparent decoupling between market expectations and the Fed’s policy. As stated in the Minutes:
Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.
Source: Minutes of the FOMC from December 13-14, 2022
This is as clear as it gets when it comes to the Fed’s communication skills. In other words, the Fed is telling market participants the following: “we’re not bluffing.”
On page 10, the Minutes still noted that:
Many participants highlighted that the Committee needed to continue to balance two risks. One risk was that an insufficiently restrictive monetary policy could cause inflation to remain above the Committee’s target for longer than anticipated. […] The other fish was that the lagged cumulative effect of policy tightening could end up being more restrictive than is necessary to bring down inflation to 2 percent and lead to an unnecessary reduction in economic activity […].
Source: Minutes of the FOMC from December 13-14, 2022
While the statement in itself is not conclusive of a growing split among Fed officials, it does show that both sides of the argument are heavily debated.
Fed pivot incoming?
The Fed was clear that the fight against inflation is not over. Market participants – clearly still addicted to the era of free money and looking for the next fix courtesy of the Fed – should not expect any Fed pivot.
Several participants commented that the medians of participants’ assessments for the appropriate path of the federal funds rate in the Summary of Economic Projections, which tracked notably above market-based measures of policy rate expectations, underscored the Committee’s strong commitment to returning inflation to its 2 percent goal.
Source: Minutes of the FOMC from December 13-14, 2022
Market participants betting that the Fed will not hold interest rates at around 5% (the terminal Fed fund rate) to drag inflation back down might be for a rude awakening. Trade cautiously.
Indeed, the Minutes revealed:
No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023. Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time.
Source: Minutes of the FOMC from December 13-14, 2022
The Fed remains flexible and is keeping its options open
The Fed highlighted the ongoing uncertainty regarding the inflation and economic growth. As usual, the Committee emphasized that future decisions will depend on the incoming data.
In light of the heightened uncertainty regarding the outlooks for both inflation and real economic activity, most participants emphasized the need to retain flexibility and optionality when moving policy to a more restrictive stance. Participants generally noted that the Committee’s future decisions regarding policy would continue to be informed by the incoming data and their implications for the outlook for economic activity and inflation, and that the Committee would continue to make decisions meeting by meeting.
Source: Minutes of the FOMC from December 13-14, 2022
[…] There will be a small sense of relief and markets will trend up a little bit. But, as we mentioned here, Fed officials won’t like this unexpected easing of conditions and expect some tough talks […]