FOMC minutes suggest threat of further interest rate rises remains; but consensus on the Committee is fraying

Yesterday’s FOMC minutes probably confirmed to the market the concern that it had been harbouring, namely that the Fed still considers the threat from inflation to be prevalent and that the potential need for further interest rate rises remains. The hoped for dovish tilt continues to remain elusive. However, in a sign that possibly the Fed has done enough, cracks among FOMC members on the direction of policy going forward are clearly growing and the gap between the ‘doves’ and the ‘hawks' is widening. Unfortunately for the market, as things stand at present, the ‘hawks’ still out-number the ‘doves’.

In a sign of unity, it was reported that all Committee members are in broad agreement that many of the factors that initially drove inflation higher are now receding and going into reverse. This would include things such as the large increase seen in retailors margins and the jump in prices of second-hand cars. Further, the softening being seen in core goods prices, including online prices, and slowing increases in shelter costs were also acknowledged. Although in a similar vein to the picture reported in the UK inflation numbers yesterday, it was noted that downwards pressure on core services prices so far remains absent.

But the biggest bugbear for the FOMC continues to be the labour market, where on-going strength in wages growth is still seen as a threat to pricing stability, the current pace of wage rises clearly inconsistent with the Fed’s 2% CPI target. The Fed has made it very clear over the past year that it would rather over-tighten policy than under-tighten, and therefore the fact that a majority of members remain inclined to tighten policy further in order to stamp out this excess wages growth should not be a surprise.

However, clearly some members are becoming concerned about the lagged impact of the hikes delivered so far on economic activity. This was alluded to by referencing the fact that monetary policy is already in restrictive territory and that the effects of the tightening delivered already could yet prove to be more substantial than currently anticipated. The risks to the Fed achieving its goals are increasingly seen as becoming more two-sided. The public remarks that have been made by various Fed officials over the past few weeks have certainly started to suggest that the strong degree of consensus on the FOMC that has largely underpinned the aggressive tightening campaign to date may be starting to fray. For example, Philadelphia Fed Governor Harker has suggested that there may be no need for further interest rate hikes, in direct contrast to the view expressed by Fed Governor Bowman who has said further hikes are likely needed. This growing tension has probably been one of the reasons why Fed Chair Powell, after last month’s meeting, commented that monetary policy decisions going forward would be decided on a meeting-by-meeting basis, ie data-dependent. It is harder for advocates on either side of the policy fence to argue for a position that is not supported by hard data.

Current market pricing shows that investors are not expecting any further interest rate rises to be forthcoming, with a small chance of a rate cut even appearing as soon as December. With the next FOMC meeting not scheduled until 20th September, there is still a further set of employment and inflation data to absorb before the Committee must make a further decision, and so far the emerging data suggests that inflationary pressures are indeed now cooling. The recent quarterly Employment Cost Index – the Fed’s preferred measure of labour pricing – showed the pace of increases in labour costs to be decelerating, while the various measures of pricing pressures in the US economy have all recently been showing inflationary pressures starting to fade.

But the key data for the FOMC will remain the CPI numbers and our expectation is that the numbers to be released on 13th September will favour the Committee pausing. But the wildcard, as ever, will be the August labour report due on 1st September; with the ‘hawks’ on the FOMC still in the majority, a strong set of numbers may be enough to see another rate hike ultimately delivered, a move which we think would be a mistake.