Fed Minutes Depict Uncertainty Surrounding Future Rate Hikes

The minutes from the May 2-3 Federal Open Market Committee (FOMC) meeting reiterated that curtailing inflation remains the principal objective of the Fed.

On the current state of the economy, the Committee members noted that “economic activity had expanded at a modest pace in the first quarter. Nonetheless, job gains had been robust in recent months, and the unemployment rate had remained low. Inflation remained elevated. Participants agreed that the U.S. banking system was sound and resilient.”

When discussing credit conditions, participants noted that, “stress in the banking sector would, in coming quarters, likely induce banks to tighten lending standards by more than they would have in response to higher interest rates alone.” Participants noted however, that the economic impact was uncertain at this time.

On the future path of monetary policy, committee members stated that “in light of the lagged effects of cumulative tightening in monetary policy and the potential effects on the economy of a further tightening in credit conditions, the extent to which additional increases in the target range may be appropriate after this meeting had become less certain.” Several participants noted however, that if the economy progressed in line with their current projections, future rate hikes may not be warranted.

When discussing factors that could weigh on future policy decisions, participants cited, “the degree and timing with which cumulative policy tightening restrained economic activity and reduced inflation, with some participants commenting that they saw evidence that the past years’ tightening was beginning to have its intended effect.”

Today’s minutes confirmed that additional rate hikes will depend on the incoming data. Despite showing some early signs of easing, inflation remains well-above target while the economy continues to add jobs at an above trend pace. This has created diverging views on the future path for the fed funds rate among FOMC members. Financial markets have adjusted their view for the fed funds rate expecting approximately 50 basis points in rate cuts by year end, versus 75 basis points two weeks ago. This uncertainty has been reflected in the volatility of the U.S. 2-year Treasury, which has gained more than 50 basis points since the beginning of May.

While tighter credit conditions stemming from the recent stress in the banking sector are expected to weigh on economic growth, the full impact remains somewhat uncertain. It is for that reason that the FOMC will likely pause on its tightening campaign when they meet next month, as they try and better gauge the cumulative impact of the 500 basis points of tightening done over the last year.