Minutes from the Federal Reserve’s policy meeting in December support officials’ hawkish turning point and suggest earlier and faster interest rate increases in addition to a faster start to normalization of the central bank’s massive balance sheet – in itself a form of policy tightening.
The minutes of the meeting, published on Wednesday afternoon, follow the meeting on 15 December, where decision-makers signaled three interest rate increases this year and three the following year as inflation concerns deepened. After months of describing price pressure as “temporary”, the Fed dropped the term and intimidated investors with new concerns just as a new variant of Covid-19 appeared. Fed Chairman Jerome Powell changed the tone to emphasize the ongoing pandemic’s risk of inflation, via ongoing supply chain problems, as opposed to growth.
Minutes from the meeting give investors more context in the officials’ latest discussions. The participants “generally noted that given their individual outlook for the economy, the labor market and inflation, it may be justified to raise the federal fund rate faster or at a faster pace than the participants had previously expected,” the minutes state. Several participants “looked at labor market conditions as already largely in line with maximum employment.” Together, these passages suggest that the first rate hike may come as soon as March.
“Given the two concerns about rising inflation and the potential for negative growth surprises, you can see why it is urgent to complete the downsizing as soon as possible, while still allowing for the timing of the first rate hike,” said Chris Zaccarelli, chief investment officer for Independent Advisor Alliance.
At the same time, Fed officials began discussing how to begin shrinking the balance of nearly $ 9 trillion, which has increased by about $ 4 trillion since the start of the pandemic and represents about 40% of US gross domestic product. Some economists say how the Fed handles balance sheet normalization may have a greater impact on markets than the timing and pace of interest rate hikes.
“Almost all participants agreed that it would probably be appropriate to start balancing runoff at some point after the first increase in the target area for federal funds interest rates. previous experience “, it says in the minutes, with officials noting that current conditions included stronger economic prospects, higher inflation, and a greater balance and thus could justify a potentially faster pace of key policy rate normalization.
Compared to the last round of balance runoff, which was underway before the pandemic hit, “this is a rapid and furious normalization,” said Omair Sharif, president of Inflation Insights LLC. Sharif says the discussions around not only the appropriate size and composition of the balance sheet, but also the timing of the runoff, are much more detailed than many investors probably expected.
The shares fell after the relatively hawkish set of minutes. The
fell 1.3% while the more interest rate sensitive
fell 2.5 percent.
After minutes, many economists and strategists say the Fed is likely to raise interest rates faster and shrink its balance sheet faster than investors have expected. What is more difficult to predict, says Zaccarelli of the Independent Advisor Alliance, is the level of market despair officials are willing to tolerate before changing course.
“Is it 15%? Or 20%? We think the Fed will tolerate some short-term volatility in the stock market to remove all the monetary accommodation they have injected into the markets,” Zaccarelli said. from the stock market – say a fall of 20% – and will stop their activities in that case.
For now, investors are facing the reality of normalizing policy. There will have to be a lot more pain before markets scare the Fed.
Write to Lisa Beilfuss at firstname.lastname@example.org