FOMC Adopts Flexible Policy Assessment, Meeting by Meeting

In response to the complex challenges and uncertainties tied to balancing potential inflationary pressures against notable risks to economic expansion, the Federal Open Market Committee (FOMC) has adopted a flexible approach. The monetary policymaking body of the Federal Reserve System will now assess its policy on a meeting-by-meeting basis.

This new strategy was revealed during their July gathering when the FOMC made the decision to increase the fed funds rate by 25 basis points to 5.375%. This decision, which met market expectations, reflects the committee’s confidence in the durability of the U.S. economy and the efficacy of previous policy changes. The rate hike also signals the FOMC’s belief in the economy’s resilience to higher borrowing costs.

In terms of economic performance, the FOMC enhanced its assessment of the country’s Gross Domestic Product (GDP) growth from ‘modest’ to ‘moderate,’ indicating a strengthened perspective on the economy’s performance. Additionally, the Committee noted robust job gains, further underlining the positive employment trends.

Despite these positive signs, FOMC Chair Jerome Powell highlighted that the full effects of the policy tightening have not yet been fully experienced. He further stressed that credit conditions are anticipated to tighten even more, which could potentially impact borrowing costs for both businesses and consumers.

Addressing inflation, Powell expressed that while significant progress has been made in controlling it, levels remain elevated. He explained that although core goods inflation has dipped below the 2.0% year-on-year target, the momentum of the shelter component remains high, indicating ongoing price pressures in the housing sector. However, Powell also mentioned that inflation in sectors other than housing is currently benign but cautioned that the full effect of the rate hikes is yet to be felt.

The FOMC now perceives the downside risks to the economy to be as significant as the uncertainties surrounding inflation. These considerations will guide future policy decisions, which Powell stated would depend on incoming data and how it aligns or conflicts with existing information. He also clarified that while financial conditions need to remain restrictive through the end of 2023, this does not necessarily mean keeping term interest rates at their current level. Instead, the FOMC aims for the decline in term rates to lag behind the deceleration in inflation, maintaining real interest rates significantly above zero.

Powell suggested that the Committee should consider policy lags, meaning they should stop hiking and initiate cuts before inflation reaches the 2.0% year-on-year target. This suggestion aligns with market expectations of a possible first rate cut in March 2024. Powell also hinted at a return to a neutral or even expansionary policy setting once inflation risks have been mitigated, which could lead to a significant reduction in the fed funds rate to around 2.50%.

The future path of the fed funds rate will depend on various factors, including capacity constraints within the U.S. economy, particularly in the housing sector, and the evolution of inflation expectations. The balance between nominal wage growth and inflation will also play a crucial role in determining broader inflation trends and their persistence. The FOMC’s adoption of a meeting-by-meeting approach highlights its commitment to adapting its policy according to changing economic conditions.