The Federal Reserve intends to continue raising interest rates to combat inflation, according to the minutes from its most recent meeting. The Fed’s pursuit of this strategy is driven by concerns that tight labour markets in the US are resulting in higher wages that could drive inflation upward. Despite a strong US economy, the recently implemented strategy has led to market crashes and a mid-term trend of lower prices in markets. The bank has, however, modified the minutes of its meeting in response to concerns over inflation, according to former Fed insider Danielle di Martino Booth.
The Fed’s Latest Meeting: What It Means for the Markets
If you thought that the Fed was done raising interest rates, think again. Last week, the Federal Reserve released the minutes of its most recent meeting and it revealed that its top brass are determined to stay the course. This was a surprise for many as Jerome Powell has talked a lot about disinflation recently, yet the minutes did not mention it even once. Today, we summarize the minutes of the Fed’s most recent meeting and tell you exactly what they could mean for the markets.
Raising Interest Rates to Fight Inflation
The Fed has been raising interest rates to fight inflation since last spring. Higher interest rates make it harder to borrow money and makes existing debt more expensive. The result is that money flows out of all assets, hence why the markets have been mostly crashing.
Market Rally Caused by Leveraged Traders and Expectations
The stock market and the crypto market have basically been rallying since late last autumn. This rally was caused by a combination of factors, namely expectations from investors that inflation was coming down and leveraged traders having to cover short positions or getting liquidated.
Unemployment Decrease and Inflation Rise
For context, the Fed is supposed to keep inflation at around 2 percent and unemployment at around 4 percent. The fact that unemployment has continued to go down even while the Fed has been raising interest rates therefore means that the Fed has room to raise interest rates even higher. More importantly, a tight labor market means there’s a risk of employees getting raises that are much higher than inflation. If too many people start getting raises higher than inflation, this could cause inflation to stay higher for longer.
The Fed’s Dual Mandate
This so-called wage-price spiral is something that the Fed has been extremely concerned about. As such, you could say that the Fed has been intentionally trying to raise unemployment to prevent this, but it doesn’t seem to be working. The Consumer Price Index or CPI for January also came in higher than expected, as did the Producer Price Index or PPI. Meanwhile, the Personal Consumption Expenditures or PCE, the Fed’s favorite inflation measure, actually rose in January, suggesting a second wave of inflation.
The Fed and the Markets
Given that this was the opposite of what investors were expecting even just a few weeks earlier, the markets crashed and have since resumed their long-term downtrend. For the most part, it’s against this backdrop that the Fed released the minutes of its most recent meeting, which took place on the last day of January and the first day of February.
Fed’s Voting Members
The minutes begin with an overview of the four new voting members of the Federal Open markets committee or FOMC. This group of 12 changes each year with four rotating in and four rotating out. The consensus is that the four new voting members will make the Fed ever so slightly more dovish, meaning it’s more likely to pause or lower interest rates.
Higher Interest Rates Can Lead to More Spending
The Fed doesn’t like the fact that markets have been rallying. This is because higher stock prices can lead to more spending as the average person feels wealthier than they really are. Fed officials discuss the fact that the US economy is likely to slow down because of higher interest rates but apparently couldn’t agree on how bad the decline will be.
Fed Officials See Interest Rates at Around 5
The minutes reveal that fed officials still see interest rates at around 5, which means there are one or two more 0.25 rate hikes still to go. Fed officials also stress the need to keep interest rates high until at least the end of the year, something that investors apparently still haven’t properly priced in.
Complexity of Bank of Japan’s Monetary Policy
Fed officials touched on the surprising economic strength in Europe and China’s reopening before breaking down the impact of the Bank of Japan’s monetary policy on the value of the US dollar. This seems to have been one of the most overlooked macro factors, probably because it’s quite complex.
Impact of China’s Reopening
In short, the Bank of Japan or BOJ has been artificially keeping interest rates in the country at zero by buying up the Japanese government’s debt. This has caused many Japanese investors to invest more heavily in foreign assets. However, the BOJ recently signaled that it may raise interest rates again.
All in all, the Fed’s meeting minutes revealed that the Fed is still intent on raising interest rates to fight inflation, and the markets may not be so keen on that. Investors should keep an eye on new developments, especially the Bank of Japan’s interest rate policy and the effects of China’s reopening on the global economy. Keep calm and invest wisely!