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Federal Reserve Chairman Jerome Powell in June 2022.
Kevin Deitch/Getty Images
Minutes from the Federal Reserve’s June 14-15 meeting revealed growing concern among central bankers about inflation and plans to adopt a restrictive policy stance to cool rapidly rising prices.
The protocol read hawkish. However, major stock indexes rose after the release as investors took stock of economic developments since the Fed’s last meeting and bet that slowing economic growth will ultimately limit the amount of tightening the central bank needs to do. Both the S&P 500 and Nasdaq 100 gained about 1% within an hour of the publication.
Members of the Federal Open Market Committee, the Fed’s policy-making body, agreed in June that a 0.5 percentage point or 0.75 percentage point rate hike would likely be appropriate in July after agreeing to up 0.75 percentage points in June. It was the biggest rate hike since 1994, prompted by a hot consumer price index and a surprise jump in consumer inflation expectations just ahead of the June meeting. These two data points dashed hopes that inflation had already peaked and set off alarms that inflation was taking hold.
Investors already knew the Fed was between a half-point and another three-quarter point hike for July. Fed Chairman Powell suggested the base case was the former, although he did not take another 0.75 point hike off the table. Traders have estimated about a 90% chance of a 0.75 point increase in July and the minutes should not change that expectation.
The question remains what will happen after July. On the face of it, the latest minutes of the meeting show that the Fed will remain hawkish, with hikes of 0.5 percentage points, the new moves of 0.25 points and officials suggesting that they will err on the side of tightening too much.
“Participants agreed that the economic outlook calls for a shift to a more restrictive policy stance and acknowledged the possibility that an even more restrictive stance may be appropriate if elevated inflationary pressures persist,” the minutes said.
But one of the big reasons for the 0.75 percentage point rise was data that has since been revised lower, possibly alleviating some panic that is palpable in the minutes. This is while commodity prices are falling, further raising hopes that inflation – at least on the goods side of the economy – has peaked.
As for the revised data that was key to the huge increase: Officials expressed particular concern about the University of Michigan’s 5-10-year measure of inflation expectations in the university’s monthly consumer confidence report. That figure jumped from 3% to 3.3% just before the June meeting. “Many participants expressed concern that long-term inflation expectations may begin to rise to levels inconsistent with the 2% target,” the minutes said, adding that those participants said that if inflation expectations remained unanchored, it would it will be more expensive to return inflation to target.
Soon after the June meeting and the 0.75 point decision, however, the University of Michigan released its revised report, with the figure for expected inflation over 5-10 years revised up to 3.1%. It noted that the revised reading was back within the 2.9% to 3.1% range that has held for the past year or so.
However, inflation expectations remain well above the Fed’s 2% target. And while falling commodity prices, rising mortgage rates and warnings from companies including retailers are supporting hopes that inflation has finally peaked, a peak is one thing and a fall is another. Consider what economists at Goldman Sachs said this week. Annual core CPI, which excludes food and energy, will accelerate again this summer to 6.3% in September from 6% in May, they said. It will still be 5.5% by the end of the year, they added, which is almost three times the target annual inflation rate.
Markets have already shifted their focus from inflation to growth – and even more so after the big increase in June and ahead of a potential similar increase this month. It is unclear when the Fed will change its focus and whether inflation will remain high even as growth slows. The June minutes give no indication that officials are beginning to waver. But things are moving fast and the protocols are already three weeks old.
Still, Citi economists say markets are underestimating the Fed’s likely rate hike path. There is now a consensus not only to move interest rates into “tight” territory, but also for policy to move “even tighter” if inflationary pressures increase, they noted after the minutes were released.
“What markets want to hear now is what the Fed has in mind if economic data releases continue to signal a deeper, more severe downturn without a commensurate reduction in inflation,” said Quincy Crosby, chief equity strategist at LPL Financial. What markets are hoping for is that by the next meeting, inflation will have plateaued, indicating that the Fed’s policy is working, she says.
For that, investors will have to keep waiting. At this point, economists expect the June CPI report, due on July 13, to show that overall prices rose another 8.6 percent from a year earlier.
Email Lisa Beilfuss at lisa.beilfuss@barrons.com
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