SocGen - Fed meeting notes: Warns of significant upside inflation risks, may require further rate hikes

At the July FOMC policy meeting, Fed officials remained largely concerned that inflation would not subside and that further rate rises would be needed, while cracks in that consensus became increasingly apparent.

Minutes of the Federal Reserve's July 25-26 policy meeting released early Thursday morning Beijing time showed that,Most participants continued to see significant upside risks to inflationThat would probably require further monetary tightening, but two Fed officials preferred to keep rates on hold or thought "such a proposal could have been supported" rather than the rate hike ultimately approved at the end of the meeting, with several participants warning of the risk of accidental over-tightening.

In a note following the release of the meeting notes, Evercore ISI economists led by Krishna Guha said: "The July FOMC meeting notes showed a tension between inflation data slowing faster than the Fed expected and stronger economic growth data than the Fed expected."

Bloomberg economist Stuart Paul said that while the post-meeting statement and voting results showed the committee was united, theMeeting notes confirm the existence of dovesThe bond market's bet on the end of the rate hike cycle may be accurate.

While updated quarterly forecasts in June showed that most officials at the time were leaning towards two more rate hikes in 2023, Federal Reserve Chairperson Jerome Powell stressed after the July resolution that the Fed would make decisions meeting by meeting. "We intend to keep tightening again until we are confident that inflation will continue to decline to our 2 percent objective, and we are prepared to tighten further if appropriate," Powell told reporters on July 26.

After the meeting notes were released, U.S. Treasury yields rose, the 30-year yield reached a new high in 2023, while the S & P 500 extended its losses, the dollar also extended its gains, and gold fell below $1,900 an ounce as the minutes showed more rate hikes.

Some Federal Reserve officials are becoming cautious about raising interest rates too much

The July meeting notes have added colour to public comments by FOMC officials in recent weeks suggesting that the strong consensus that underpinned the aggressive tightening actions of the past year and a half may be starting to wane. Some, such as Philadelphia Fed President Chuck Harker, have suggested that the Fed may not need to continue raising interest rates. Others, including Fed Governor Bowman, have taken the opposite view.

Nick Timiraos, a "Fed mouthpiece", wrote that the minutes showed that most Fed officials supported a rate hike last month, but some were concerned that rates could be raised too high, highlighting the Fed's cautious attitude towards further rate hikes.Some Federal Reserve officials are concerned that with a tight labor market enabling workers to negotiate higher wages, underlying price pressures could become more persistent, making it harder to reduce inflation further.

The meeting notes that several participants felt that given the restrictive territory of monetary policy and the upside and downside risks to the Fed's committed objectives, it was important to balance the risks of excessive and insufficient tightening. Uncertainty about the US economic outlook remains high and future decisions will be based on data.

According to futures contracts, investors currently do not expect another rate hike this year, but the likelihood of a rate hike at the November meeting is higher than at the September meeting. They still believe the Fed will start cutting rates in 2024, with the base rate falling to around 4.25% by the end of next year.

Fed watchers will be looking for more clues at the Kansas Fed's annual meeting in Jackson Hole, Wyoming, next week, where Powell is expected to speak.

The labor market remains very tight

Most of the main economic data released since the July meeting supports the view that Fed officials will have some time to consider whether further monetary tightening is needed. Quarterly data on employment costs and unit labour costs showed slower growth, while consumer prices excluding food and energy posted their smallest monthly increase in more than two years. Participants said,The labour market remains "very tight"But there were signs that labour demand was balancing out, with participants saying the rate rises were having the desired effect compared with the uncertainty of lagging monetary policy.

Global inflation has declined

The minutes show that headline foreign inflation has continued to fall, partly reflecting the transmission of earlier declines in commodity prices into retail energy and food prices. Core inflation has fallen modestly in many countries, but remains high overall. Against this backdrop, many advanced central banks have raised policy rates as labour markets remain tight, and emphasised the need to raise them further or keep them at levels strict enough to bring inflation back to target. By contrast, central banks in emerging market economies have remained largely unchanged, with some saying they may even cut rates at their next meeting.

The economy is no longer expected to enter a mild recession before the end of the year, and core inflation will decline significantly in the second half of the year

The meeting notes also expressed some optimism about the outlook as the Fed's influential economists"No longer think the U.S. economy will enter a mild recession by the end of the year"However, staff still expect real GDP growth in 2024 and 2025 to be lower than their estimates of potential output growth, which would cause the unemployment rate to rise slightly relative to current levels

Participants also expected a decline in headline and core PCE price inflation over the next few years. Most of the decline in core inflation is expected to occur in the second half of 2023, with forward-looking indicators showing a moderation in housing service price increases and a moderation in core non-housing service prices and core commodity prices for the remainder of 2023. Further easing in inflation is expected in 2024 as supply-demand imbalances continue to be resolved, with total PCE price increases projected at 2.2% and core inflation projected at 2.3% through 2025.

The credit situation in the United States is generally solid

Overall, credit quality remains solid for most businesses and households, the minutes show. While there are signs of deterioration in credit quality in some sectors, such as the office arm of commercial real estate, delinquency rates remain close to pre-epidemic lows overall. Credit quality on banks' balance sheets remains good as of the end of Quarter 1, 2023. Fed staff also warned that fundamentals in the commercial real estate sector "could decline significantly and lead to a deterioration in credit quality".

Societe Generale InvestmentFed officials said tighter credit conditions "could weigh on economic activity, hiring and inflation" but noted that the extent of the impact was uncertain, a key question for policymakers at the moment, institutional analysts said. Credit conditions are one of the main ways in which policy is transmitted, especially as labour market and consumer conditions remain strong.

It is still possible to continue to shrink the balance sheet after the interest rate cut

There wasn't much discussion of quantitative tightening in the meeting notes. Powell said at the news conference that it was possible to continue shrinking the balance sheet even after starting to cut rates. Many participants noted that when the committee finally starts cutting rates, it doesn't need to end shrinking the balance sheet.