Yesterday saw the release of the Fed’s minutes, which are the documents of the recent meetings of the Federal Open Market Committee, better known by its acronym FOMC.
The FOMC is the body of the US central bank, i.e., the Federal Reserve (Fed), that oversees the open markets in the United States and, most importantly, decides its monetary policy.
Its main role is to regulate short-term monetary policy by deciding the level of interest rates in the US.
Interest rates and the decisions of the Federal Open Market Committee
For many months now, the Fed has decided to raise and continue raising interest rates in an effort to keep inflation at bay.
The problem is that high interest rates are not good for the money markets, and in particular for the economy, so much so that in the US many people are calling on the Fed to stop raising them, or even lower them, to reduce recession risks.
However, the Fed has long ago made it clear without a shadow of a doubt that it is giving absolute priority to fighting inflation, so as long as inflation remains well above 2% it is very difficult to imagine a reduction in rates.
The financial markets understood this very well, so they did not react particularly badly to the FOMC minutes yesterday.
In February last year, effective rates were still very low, 0.08%, according to official Fed data.
As early as March, however, they were raised to 0.20%, and over the course of 2022 they were raised several times until they reached 4.10 % in December.
This is a very important and, above all, very fast increase, the likes of which have not been seen in decades. However, the financial markets have now put their minds at rest, and apparently still expect further rises during 2023. The first of these is expected to take place in early February.
As CNBC reveals, the minutes released yesterday by the Fed state that FOMC members expect interest rates to remain high until significant progress is made in fighting inflation.
Truth be told, from the September peak of 9.1%, overall inflation in the US had already fallen to 7.1% in November, with five consecutive months of decline.
However, it is worth mentioning that 7.1% is still considered an excessive level, partly because it started from a level below 2% in early 2021. The Fed’s goal for now still seems to be to bring inflation back to 2%.
Since November’s 7.1% is still a long way from 2%, FOMC members do not see a rate cut as useful at this time. On the contrary, the minutes state that no FOMC member expects a rate cut during 2023.
What is not clear, however, is whether or not there will be new increases.
Much will depend on the data regarding inflation in December and January, because in case they do not confirm the strong downward trend of November, it is very likely that the Fed may continue to raise them.
Conversely, in the event that the December and January data confirm a strong downward trend in inflation, the FOMC may decide either to raise them again, to try to deliver the final blow to inflation, or to stop raising them, as requested by much of the US manufacturing system.
The minutes also reveal that FOMC members believe it is necessary to maintain the Fed’s current restrictive monetary policy until there is certainty that the inflation trend is on a downward path pointing straight to 2%.
This will presumably take some more time. In fact, FOMC members argue that historical experience warns against a premature easing of restrictive monetary policy.
In fact, it cannot be ruled out that inflation could rise again, or that the downward path could be interrupted.
The next rate hike
However, the minutes reveal that the FOMC has already considered at least reducing the monthly rate hike, i.e., raising it from +50 basis points to +25 basis points. However, this is only a hypothesis that will be subject to revision once data regarding December and January inflation are available.
Financial markets, however, are currently already discounting the likelihood that the next increase will be 50 basis points or even 75, so in case it is 25 points instead, they might react well. Since the next FOMC meeting will be held between 31 January and 1 February, it will not be able to consider the updated January data regarding inflation, which will not yet be available, but only the December data, which will be released in a few days.