Fed Minutes Offer Detail On Likely December 14 Rate Hike

The U.S. Federal Reserve (Fed) released the minutes of its November 1-2 meeting on November 23. The minutes showed the Fed’s continuing concern over the risk of costly entrenched inflation. The Fed is concerned about the tight U.S. labor market driving strong wage growth. This wage growth could continue to prompt further inflation in the Fed’s view.

This implies another hike when the Fed sets rates on December 14, of perhaps 0.5 percentage points, and maybe further, smaller, rate increases during the first few Fed meetings of 2023.

Still, some policy-makers are starting to suggest that rates may now have risen to close to where the Fed wants them. The minutes stated that, “a substantial majority of participants judged that a slowing in the pace of [interest rate] increase would likely soon be appropriate.” Though here, the Fed wants to point out that that doesn’t mean it will start cutting rates, but simply hold them at a high level as the impact of monetary policy is felt over time.

Entrenched Inflation Fears

Recent softening inflation data, including one encouraging CPI report after the Fed’s November meeting, has put the Fed somewhat on the defensive. The markets have interpreted recent inflation data relatively positively. Many expect the Fed to draw back on hikes soon. Fed officials are generally communicating a more cautious stance here. The Fed reiterated its concerns, as stated in the November meeting minutes, with multiple references to the importance of keeping inflation “well anchored” and inflation being “unacceptably high”.

These recent Fed minutes help explain some of the apparent disconnect between the Fed and markets. The Fed sees that inflation could be improving too. Ultimately though the Fed’s goal is 2% inflation, not falling inflation, and the Fed still worries a great deal about inflation getting out of control. The Fed uses the term “unanchored” inflation for this, and is concerned that it could happen in several ways.

Wage Growth Risks

The Fed’s main concern is that inflation does not fall back to target relatively quickly. These fears are grounded, in part, by a tight jobs market and relatively high wage growth. The minutes mentioned how wage grow continues to run at 5% for the year to September 2022. The Fed interprets strong wage growth as a potentially fueling inflation. As much as markets are watching for inflation directly for signs of softness, the Fed would like to see the jobs market cool down too and believes this may be starting to happen. The Fed discussed some risk of a “wage-price spiral” fueling inflation, though this has not occurred yet in the Fed’s view.

The minutes stated that below trend GDP growth would be “helpful” in fighting inflation. This makes clear just how committed the Fed is to its inflation fight. Representing slower growth as a potential inflation-fighting tool, rather than a risk to the broader economy, as the Fed would likely interpret it if inflation weren’t such a concern.

Downside Risks

The Fed doesn’t necessarily disagree with the markets’ view that inflation may be trending down. However, the Fed remains very concerned over the potential for entrenched inflation, even if this is not the most likely scenario.

If inflation expectations do get out of hand, the Fed is worried that higher rates for longer will be needed to bring inflation back to target and would be “costly”. The Fed would rather be more cautious with rates now, rather than not finish the job and leave inflation well above target for longer.

Continued high wage growth is one reason the Fed isn’t ready to declare victory in the inflation fight yet. Another risk, in the Fed’s view, is quitting too early and the costs if inflation remains elevated for too long. That’s one reason we should expect another meaningful hike of perhaps 0.5 percentage points when the Fed sets rates on December 14, but early 2023 meetings may see the Fed move to smaller hikes or holding rates steady.