January Minutes Show Fed Ready to Move Faster if Inflation Doesn’t Moderate
by Craig Dismuke, Dudley Carter
Fed Minutes Show Optimism about Growth but Angst about Inflation: There were few surprises in the Minutes from the Fed’s January 25-26 meeting, although the economic situation has evolved since the meeting with the most recent readings on the labor market and inflation producing stronger-than-expected results. When the Fed met in January, officials noted that activity remained strong but held back by economic imbalances, primarily a shortage of workers and supply chain congestion. As a result of those dynamics, “elevated inflation was persisting longer than they had anticipated” and had “broadened beyond sectors most directly affected by those factors.” Additionally, there was a lengthy discussion of factors that led officials to conclude “risks to inflation were weighted to the upside.”
Inflation Moderation Key to Preventing More Aggressive Rate Hikes: Against the backdrop of a strong labor market and elevated inflation that was evident in late-January, officials concluded, “it will soon be appropriate to raise the target range for the federal funds rate” and “most participants suggested that a faster pace of increases in the target range for the federal funds rate than in the post-2015 period would likely be warranted.” They went on to say, “if inflation does not move down as they expect, it would be appropriate for the Committee to remove policy accommodation at a faster pace than they currently anticipate.” Subsequent to the January meeting, January’s CPI report was stronger than expected and showed that pressures continued to broaden out across categories. A couple of Fed hawks have since noted that the inflation data have increased the urgency for the Fed to tighten. This week, January’s PPI inflation report also came in notably hotter than expected on broad firmness.
Fed Expects Faster and Significant Run-off of the Balance Sheet: As relayed by Chair Powell after the January meeting, the Minutes stated, “participants generally noted that current economic and financial conditions would likely warrant a faster pace of balance sheet runoff than during the period of balance sheet reduction from 2017 to 2019.” While specifics were pushed to later meetings, “Participants observed that, in light of the current high level of the Federal Reserve’s securities holdings, a significant reduction in the size of the balance sheet would likely be appropriate” and the process was expected to begin “sometime later this year.” Although there was general agreement for shrinking the balance sheet in a “predictable manner primarily by adjusting the amounts reinvested of principal payments,” it was also noted by “many” participants that “sales of agency MBS or reinvesting some portion of principal payments received from agency MBS into Treasury securities may be appropriate at some point in the future.”
Bottom Line: The Fed was clearly anxious about inflation at the January meeting and many believed the labor market was quickly approaching, if not already at, maximum employment, at least in the short-term. Data since the meeting have shown continued strength in the labor market and further strengthening and broadening of inflation. These developments help explain the shift in market expectations from the time of the meeting until today. Futures closed January 26 pricing in four quarter-point hikes this year with a roughly 25% chance of a fifth. As of today, markets expect six quarter-point hikes with a roughly 30% chance of a seventh. The January Minutes confirm that inflation data will determine how fast the Fed removes policy accommodation this year.