Fed Expects Restrictive Policy of Higher Interest Rates for Longer: FOMC Minutes

Federal Reserve Board Chair Jerome Powell speaks during a news conference following a two-day meeting of the Federal Open Market Committee (FOMC) in Washington, on July 27, 2022. (Elizabeth Frantz/Reuters)

The Federal Reserve will eventually slow the pace of interest rate increases as officials assess the cumulative effects of monetary policy adjustments, according to minutes from the September meeting of the Federal Open Market Committee (FOMC) released on Oct. 12.

However, the central bank reiterated its position that the Fed must adopt and maintain a restrictive policy to achieve the chief objective of price stability. Once policy has reached a restrictive level, it will need to be held there for a period.

This might have been emphasized as the Fed anticipated that the real Personal Consumption Expenditures (PCE) price index, a preferred measure of inflation, is poised to record “a modest gain” in the third quarter.

Despite fears of overtightening, several rate-setting committee members say the costs of doing too little to rein in rampant price inflation are too high, even if the efforts result in slower economic growth.

“Participants generally anticipated that the U.S. economy would grow at a below-trend pace in this and the coming few years, with the labor market becoming less tight, as monetary policy assumed a restrictive stance and global headwinds persisted,” the minutes read.

“Participants noted that a period of below-trend real GDP [gross domestic product] growth would help reduce inflationary pressures and set the stage for the sustained achievement of the committee’s objectives of maximum employment and price stability.”

At the same time, the economic outlooks of FOMC participants were high, and risks to their inflation outlook were weighted to the upside.

“Some participants noted rising labor tensions, a new round of global energy price increases, further disruptions in supply chains, and a larger-than-expected pass-through of wage increases into price increases as potential shocks that, if they materialized, could compound an already challenging inflation problem,” the minutes read. “A number of participants commented that a wage-price spiral had not yet developed but cited its possible emergence as a risk.”

The FOMC lowered its economic projections, forecasting GDP to grow at a tepid annualized pace of 0.2 percent in 2022 and 1.2 percent in 2023.

Overall, the minutes reiterated what many Fed officials have been saying in public for months: The central bank needs to raise interest rates and hold them there, higher for longer, until inflation begins to show signs of coming down.

The U.S. financial markets turned positive following the minutes, with the leading benchmark indexes recording modest gains before closing slightly lower.

A Bleak Economy?

During the FOMC policy meeting in September, committee members raised interest rates by 75 basis points, bringing the benchmark federal funds rate to a target range of 3–3.25 percent.

Market analysts are worried that the institution’s efforts of quantitative tightening are beginning to seep into the broader economy, resulting in bleak monthly data.

Since the beginning of October, various metrics have been trending downward or falling short of market estimates.

The September Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) eased to 50.9 and the nonmanufacturing PMI dipped to 56.7. In August, construction spending fell by 0.7 percent, while factory orders were flat. The U.S. housing market has fallen deeper into a recession, and the labor market is beginning to show signs of cooling down.

The annual Producer Price Index (PPI) eased to a higher-than-expected 8.5 percent in September, according to the Bureau of Labor Statistics (BLS). The PPI rose by 0.4 percent month over month.

Investors will be watching the Consumer Price Index (CPI) report for September on Oct. 13. The CPI is expected to ease to 8.1 percent year-over-year, however, the core inflation rate, which excludes the volatile energy and food sectors, is projected to advance to 6.5 percent.

Optimism in the economy has been mixed. The National Federation of Independent Business (NFIB) Optimism Index rose for the third consecutive month, advancing to 92.1. But the IBD/TIPP Economic Optimism Index slumped, to 41.6, the 14th straight month that the household gauge has been in pessimistic territory.

“Data over the past month were mixed, but on balance increasingly suggest recession risk over the coming year,” Nick Reece, a portfolio manager at Merk Investments, wrote in a note. “The Conference Board’s Leading Economic Indicators (LEI) Index is down six months in a row and negative on a year-over-year rate of change basis.

“The outlook remains uncertain, with risks to economic growth clearly skewed to the downside.”

While speaking during an interview with CNN on Oct. 11, President Joe Biden dismissed the chances of a recession.

“Every six months they say this. Every six months, they look down the next six months and say what’s going to happen,“ Biden said. ”It hadn’t happened yet. It hadn’t ... I don’t think there will be a recession. If it is, it’ll be a very slight recession. That is, we’ll move down slightly.”

The U.S. economy is in the middle of a technical recession after it recorded back-to-back quarters of negative GDP growth.

And this isn’t boding well for the financial markets, either, according to Arthur Laffer Jr., president of Laffer Tengler Investments.

“Quite a bit of the current environment appears to be pricing in higher rates and lower growth and a fairly mild recession in the United States,” Laffer wrote in a recent note. “We expect a lot more volatility in markets for the remainder of the year as the inevitability of higher rates sinks in and the economic consequences become more pronounced. [Fed] Chairman Powell will not be a very popular person, but it seems his legacy is focused on fighting any resurgence of 1970s’ inflation in the United States at all costs.”

According to the CME FedWatch Tool, the market is pricing in an 86 percent chance of a three-quarter-point rate boost in November. Investors also think the odds of a 50-basis-point increase to the fed funds rate is about 58 percent.