Fed Expects Restrictive Policy of Higher Interest Rates for Longer: FOMC Minutes

The Federal Reserve will eventually slow down the pace of interest rate hikes as officials assess the cumulative effects of monetary policy adjustments, according to minutes from the September meeting of the Federal Open Market Committee (FOMC) released on Wednesday.

However, the central bank reiterated its position that the Fed must adopt and maintain a restrictive policy to achieve the chief objective of price stability. Once policy had reached a restrictive level, it would need to be held there for a period.

This might have been emphasized as the Fed anticipated the real Personal Consumption Expenditures (PCE) price index, a preferred measure of inflation, is poised to record “a modest gain” in the third quarter.

Despite fears of over-tightening, several rate-setting committee members say the costs of doing too little to rein in rampant price inflation are too high, even if the efforts result in slower economic growth.

“Participants generally anticipated that the U.S. economy would grow at a below-trend pace in this and the coming few years, with the labor market becoming less tight, as monetary policy assumed a restrictive stance and global headwinds persisted,” the minutes stated. “Participants noted that a period of below-trend real GDP growth would help reduce inflationary pressures and set the stage for the sustained achievement of the committee’s objectives of maximum employment and price stability.”

At the same time, the economic outlooks of FOMC participants were high, and risks to their inflation outlook were weighted to the upside.

“Some participants noted rising labor tensions, a new round of global energy price increases, further disruptions in supply chains, and a larger-than-expected pass-through of wage increases into price increases as potential shocks that, if they materialized, could compound an already challenging inflation problem,” the minutes noted. “A number of participants commented that a wage–price spiral had not yet developed but cited its possible emergence as a risk.”

The FOMC lowered its economic projections, forecasting gross domestic product (GDP) to grow at a tepid annualized pace of 0.2 percent in 2022 and 1.2 percent in 2023.

Overall, the minutes reiterated what many Fed officials have been saying in public for months: the central bank needs to raise interest rates and hold them there, higher for longer, until inflation begins showing signs of coming down.

The U.S. financial markets turned positive following the minutes, with the leading benchmark indexes recording modest gains.

A Bleak Economy?

During the FOMC policy meeting in September, committee members raised interest rates by 75 basis points, bringing the benchmark federal funds rate to a target range of 3.00–3.25 percent.

Market analysts are worried that the institution’s efforts of quantitative tightening are beginning to seep into the broader economy, resulting in bleak monthly data.

Since the beginning of October, various metrics have been trending downward or falling short of market estimates.

The September Institute of Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI), for example, eased to 50.9 and the non-manufacturing PMI dipped to 56.7. In August, construction spending fell 0.7 percent in August, while factory orders were flat. The U.S. housing market has fallen deeper into a recession, and the labor market is beginning to show signs of cooling down.

Is this the picture of successfully fighting inflation?

The annual Producer Price Index (PPI) eased to a higher-than-expected 8.5 percent in September, according to the Bureau of Labor Statistics (BLS). The PPI rose 0.4 percent month over month.

Investors will be watching the Consumer Price Index (CPI) report for September on Thursday. The CPI is expected to ease, to 8.1 percent year over year, but the core inflation rate, which excludes the volatile energy and food sectors, is projected to advance, to 6.5 percent.

Meanwhile, optimism in the economy has been mixed. The National Federation of Business Optimism (NFIB) Optimism Index rose for the third consecutive month, to 92.1. But the IBD/TIPP Economic Optimism Index slumped, to 41.6, the fourteenth straight month that the household gauge has been in pessimistic territory.

“Data over the past month were mixed, but on balance increasingly suggest recession risk over the coming year,” said Nick Reece, the portfolio manager at Merk Investments, in a note. “The Conference Board’s Leading Economic Indicators (LEI) Index is down six months in a row and negative on a year-over-year rate of change basis.”

“The outlook remains uncertain, with risks to economic growth clearly skewed to the downside,” he added.

While speaking during an interview with CNN on Tuesday, President Joe Biden dismissed the chances of a recession.

“Every six months they say this. Every six months, they look down the next six months and say what’s going to happen,” he said. “It hadn’t happened yet. It hadn’t … I don’t think there will be a recession. If it is, it’ll be a very slight recession. That is, we’ll move down slightly.”

The U.S. economy is in the middle of a technical recession after recorded back-to-back quarters of negative GDP growth.

And this is not boding well for the financial markets, either, says Arthur Laffer Jr., president of Laffer Tengler Investments.

“Quite a bit of the current environment appears to be pricing in higher rates and lower growth and a fairly mild recession in the United States,” he wrote in a recent note. “We expect a lot more volatility in markets for the remainder of the year as the inevitability of higher rates sinks in and the economic consequences become more pronounced. [Fed] Chairman Powell will not be a very popular person, but it seems his legacy is focused on fighting any resurgence of 1970s’ inflation in the United States at all costs.”

According to the CME FedWatch Tool, the market is pricing in an 86 percent chance of a three-quarter point rate hike in November. Investors also think the odds of a 50 basis-point increase to the fed funds rate is about 58 percent.