December 2022 Fed Meeting Minutes Reveal Fed Policy Foibles

By the Curmudgeon


Introduction:

Victor and I have been saying for a very long time that the Fed’s been talking the markets down to produce a “reverse wealth effect.”  By reducing asset prices, people feel poorer which the U.S. central bank believes would decrease consumer demand and hence lower inflation.  We first wrote about that last May in this piece.

Fed officials firmly believe they won’t be able to defeat inflation unless they can slow the economy by tightening financial conditions, such as by raising borrowing costs and lowering stock prices.

Conversely, any market rallies that ease financial conditions threaten to hinder officials’ effort to cool hiring and wage growth. That, in turn, could prompt the Fed to continue lifting rates or holding them at higher levels for longer, increasing the risk of a deeper or longer economic downturn.

Fed to Keep Raising Rates in 2023:

Seventeen of 19 Fed officials projected rates at or above 5.1% this year. By comparison, not a single official in September had forecast rates above 5% in 2023. 

Continuing the hawkish drumbeat, Minneapolis Fed President Neel Kashkari said he expects the Federal Reserve will need to raise interest rates by another percentage point over the next few months, despite signs that inflation is decelerating.

“While I believe it is too soon to definitively declare that inflation has peaked, we are seeing increasing evidence that it may have,” Mr. Kashkari said in an essay published online Wednesday morning. “In my view, however, it will be appropriate to continue to raise rates at least at the next few meetings until we are confident inflation has peaked.”

Selected Quotes from Fed’s Dec 13-14, 2022 Meeting:

The minutes of the Fed’s December 13-14, 2022 meeting, released today, confirm our “reverse wealth effect” thesis and much, much more.  Please read on and ask yourself why is the Fed so concerned with stock prices?

“Equity markets moved higher. However, equity market contacts noted risks to growth ahead, and earnings expectations for coming quarters had been marked down.”

“Broad stock price indexes increased, likely reflecting reduced concerns about the inflation outlook and the associated implications for the future path of policy. On net, the one-month option-implied volatility on the S&P 500—the VIX—decreased notably and was around the middle of its range since mid-2020.”

“In line with reduced investor concerns about the inflation outlook, spreads of interest rates on corporate debt, mortgage-backed securities, and municipal bonds to comparable duration Treasury yields all narrowed over the inter-meeting period.”

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“Regarding the outlook for monetary policy, both market- and Desk survey-based measures indicated expectations for the Committee to maintain elevated policy rates through 2023.   Participants continued to anticipate that ongoing increases in the target range for the federal funds rate would be appropriate to achieve the Committee’s objectives.”

“No participants anticipated that it would be appropriate to begin reducing the federal funds rate target in 2023. Participants generally observed that a restrictive policy stance would need to be maintained until the incoming data provided confidence that inflation was on a sustained downward path to 2 percent, which was likely to take some time. In view of the persistent and unacceptably high level of inflation, several participants commented that historical experience cautioned against prematurely loosening monetary policy.

ΰMeaning no Fed rate reductions in 2023 as long as stock and bond prices stay elevated!

“With inflation remaining unacceptably high, participants expected that a sustained period of below-trend real GDP growth would be needed to bring aggregate supply and aggregate demand into better balance and thereby reduce inflationary pressures.”

“Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”

“Looking ahead to year end (and 2023), market participants anticipated limited pressures. The manager pro tem noted that if transitory pressures emerged in money markets, the Federal Reserve’s backstop facilities are available to support effective policy implementation and smooth market functioning.” 

ΰNO CONTINGENCY PLAN FOR A CREDIT CRISIS OR TREASURY MARKET LIQUIDITY VANISHING?

Other Voices:

“A big concern of their messaging here is that the market is pricing in cuts by the second half of this year,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. With inflation too high, officials “realize that the risk of overtightening is just something that they have to swallow and stomach,” he said.

“They don’t see light at the end of the tunnel yet with inflation,” said Derek Tang, an economist at LH Meyer in Washington. “They’re so alert of financial easing that’s ‘unwarranted’ that the scale should tilt to staying with 50 basis points in February. That’ll drive the message home.”

“It seems that there is more of a consensus view that they’ve got to go above 5% than certainly I would have thought the numbers implied,” said Kevin Cummins, the chief US economist at NatWest Markets in Stamford, Connecticut.

Will Fed Continue to Raise Rates as Inflation Falls?

The Personal Consumption Index (PCI) is the Fed’s preferred U.S. inflation gauge. As the chart below shows, it’s been in a steep decline the last four months.  That’s sure to continue in 2023 with the economy slowing further due to previous jumbo rate hikes last year.

Inflation Cools in the US | Fed's preferred gauge has moderated over last three months

A much lower inflation expectation was bolstered by the most recent reading on price pressures published by the Commerce Department on Dec. 23rd, which showed so-called core inflation — excluding food and energy — rose just 0.2% in November. That was less than what was implied by the Fed’s latest projections, and monthly readings of a similar size going forward would be consistent with a return to the central bank’s 2% target.

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Cartoon of the Week:

https://d1yhils6iwh5l5.cloudfront.net/charts/resized/48140/original/05.22.2017_Fed_cartoon.png

……………………………………………………………………………………………………………………Conclusions:

The December meeting minutes also show that the Fed is unwilling to loosen monetary policy prematurely before its work is done. They also are uncomfortable with rising stock prices which they think subverts their inflation fighting mission.

Officials stressed that despite recent slowdowns in price growth, “it would take substantially more evidence of progress to be confident that inflation was on a sustained downward path,” the minutes say.

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Victor and I wish you all the best for 2023!  Till next time…………………………

 

The Curmudgeon
ajwdct@gmail.com

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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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