Fed minutes hint at another 75 bps rate hike likely

5 Jan 2023 , 10:02 AM

Two things broadly emerged from the minutes of the FOMC (Federal Open Markets Committee). Firstly, the Fed members almost reached a consensus that the pace of rate hikes had to slowdown. However, at the same time, the members also agreed that it was too early to call a top on rates without a visible assurance that inflation was headed lower. That is expected by around the middle of 2023.

In the December 2022 Fed meet, the Fed had hiked the rates by 50 bps to the range of 4.25% to 4.50%. That marks an overall increase of 425 basis points since March 2022. The Fed statement also hinted at a terminal rate of 5.1%, which corresponds to a rate range of 5.00% to 5.25%. That leaves about 75 bps of rate hikes still to happen, probably in 3 tranches of 25 bps each. The Fed minutes have broadly ratified this stance.

CME hints at a more certain range for rates trajectory

This is a quick look at the CME Fedwatch implied probabilities. The CME Fedwatch captures probability of future rate hikes based on Fed futures pricing. It captures the language of the Fed statement, macro data flows and the implications of the Fed minutes. Here is how the rate probabilities look like for the next 8 meetings.

Fed Meet	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575	575-600
Feb-23	Nil	Nil	Nil	68.1%	31.9%	Nil	Nil	Nil	Nil
Mar-23	Nil	Nil	Nil	10.8%	62.40%	26.8%	Nil	Nil	Nil
May-23	Nil	Nil	Nil	6.1%	40.1%	42.2%	11.6%	Nil	Nil
Jun-23	Nil	Nil	Nil	5.7%	37.8%	42.1%	13.6%	0.8%	Nil
Jul-23	Nil	Nil	1.1%	12.1%	38.7%	36.4%	11.1%	0.6%	Nil
Sep-23	Nil	0.4%	5.0%	21.4%	37.95%	27.5%	7.4%	0.4%	Nil
Nov-23	0.2%	2.3%	11.8%	28.3%	33.6%	19.2%	4.5%	0.2%	Nil
Dec-23	1.3%	9.2%	23.7%	32.1%	23.1%	8.5%	1.4%	0.1%	Nil

Data source: CME Fedwatch

If you compare the Fed probabilities with the day after the Fed statement and the day after the minutes, the structure almost remains the same. However, there have been some interesting probabilities, which can be summarized as under.

• The markets are still factoring in another 75 bps of rate hike in the year 2023, but what we do see is a greater probability that this could touch 100 bps rate hike in the first half if the inflation does not show too much of sensitivity to change in rates.

   

• The probability shift has been on the higher side, in the sense that there is a greater probability assigned to higher levels of Fed rates in the current year.

   

• The probability of rate cuts in the latter part of the year have also come down sharply, indicating that rates could stay elevated for longer than originally anticipated.

   

• The broad trajectory for the terminal rates still remains in the range of 5.00% to 5.25% with an outside chance of the terminal scaling up to 5.50%.

In a sense, the minutes reiterated the undertone of the Fed states that the US central bank is still not done with hawkishness. Fed has committed not to relent on high rates as long as inflation did not show visible signs of slowing down and gravitating towards the 2% mark That visibility is not there, at this juncture.

8 things we read in the latest Fed minutes

Here are some key takeaways that we read from the Fed minutes announced on 04th January 2023.

1. One thing emerges clearly from the minutes of the fed meet. There is unanimity that higher interest rates would remain in place until visible progress was made in bringing inflation down. That means; the rate cycle is not turning any time soon.

    

2. There was consensus that the Fed would adopt a gradual approach to hiking rates, and future rates could be in the range of 25 bps each. However, the minutes do hint at total rates going up by 100 bps instead of 75 bps as indicated in the Fed statement.

    

3. While the members will not wait for inflation to come down all the way to 2%, they will at least wait for the incoming data to provide confidence that inflation was on a sustained downward path to the 2% mark. 

    

4. Like Jerome Powell had warned in the Fed statement, the bigger risk for the Fed would be to embark on policy loosening tad too early. It may negate the efforts of the last one year and also reduce the influence that rates have on inflation levels.

    

5. Fed officials have also underlined that future rate hikes and the pace of the hikes would be purely data driven. Future trajectory of inflation, GDP growth, consumption patterns and labour data would have a bearing on the rate progression.

    

6. Jerome Powell himself underlined as part of the minutes that none of the Fed members expected rates to be cut in the year 2023 and any rate cuts would possibly happen only in 2024. That explains the reduced probabilities of rate cuts in 2023.

    

7. In a subject that is less discussed these days, Fed minutes also pointed out that $95 billion of maturing securities were being allowed to roll off each month rather than being reinvested. This taper approach had resulted in the Fed balance sheet compressing from $9.10 trillion to $8.64 trillion. That liquidity tightening had also accentuated the impact of rate hikes on inflation.

    

8. Fed minutes once again underlined that, like on previous occasions, it was the labour market that was showing resilience with non-farm payrolls exceeding expectations for better part of the year. Job openings in the US are twice that of available workers. As a result wages remain high and that is putting a spoke on inflation control

What RBI and India must read from the Fed minutes?

For the Indian markets, there are some interesting takeaways; and not all are positive. Firstly, the taper is likely to continue to impact FPI flows into India; especially the passive flows. Secondly, the Fed is not done with rate hikes and that means the RBI cannot confidently shift to a pro-growth stance for now. Thirdly, there is still a high probability of the US economy entering into recession in the coming months with its ramifications for Indian exports and the Indian IT and pharma sectors

Like the Fed, the RBI may also have to keep its options open in the coming policies since there are still no clear indications in India that rates are headed lower. RBI also cannot allow its commitment to inflation control to slacken. To sum up, hawkishness may continue in 2023, albeit on a more mellowed note. The challenges for growth will stay for Indian companies and it remains to be seen how it impacts GDP projections for 2023. Risks to growth may be real for India, but for now the answer lies in being data driven.