FOMC May-24 minutes still concerned about sticky US inflation

23 May 2024 , 09:57 PM

FED MAY-24 MINUTES AND THE INFLATION WORRY

The minutes of the Federal Open Markets Committee (FOMC) which concluded on May 01, 2024 was published on May 22, 2024; as is the general practice. The US Fed publishes the minutes of the Fed meet exactly 21 days after the policy statement. In its policy statement on May 01, 2024, the Fed had held interest rates in the range of 5.25% to 5.50%, as was popularly expected. However, the outlook of the Fed on interest rates continued to be ambivalent. While Jerome Powell was at his eloquent best trying to assure the markets that rates would come down in this year, other members were not so forthcoming. FOMC members like Michelle Bowman and Neil Kashkari belong to the other extreme. They has also implied that rates would be hiked, if necessary, in case the last mile inflation continued to play truant with the US economy.

Since the Fed statement on May 01, 2024, the US consumer inflation for April came in about 10 bps lower at 3.4%. However, most of the downside traction in inflation came from core inflation. While food inflation had remained flat, the fuel inflation continued to be sticky. In fact, the price of Brent Crude, which had gone up from $70/bbl to $90/bbl amidst the Red Sea crisis, has tempered in recent weeks on the back of rising US crude inventories. The US has been churning out crude at record levels, and that is bringing some stability to global prices. However, the concern here is that oil demand in the US also continues to be buoyant and hence there is only so much difference that the US oil can make to global oil prices. For now, the longer term swing factors for oil are OPEC supply and the Red Sea crisis. It is in this context that the minutes of the FOMC on May 22, 2024 need to be evaluated.

CIRCA FED MINUTES (MAY 2024) – OUR 6 KEY READINGS

It is hard to say what is more emphatic, the confidence that inflation would come down or the ambivalence on rates. Even in the latest meeting minutes, the FOMC members had clearly expressed disappointment over recent inflation readings. However, the Fed officials also expressed confidence in the same breath that inflation would come down and once the price pressures abate, there will be a clearer trajectory on rates. For now, the CME Fedwatch is still betting on the first rate cut happening in September. Here is what we read.

• The sentiments in the Fed minutes broadly reflected the confidence that inflation would eventually come down. Interestingly, the debate also touched upon the probability of rate hikes in the future. One possibility is that the Fed may be preparing the markets for a tougher run ahead. It hits two birds with one stone. It tempers market optimism on rate cuts and also keeps inflation expectations under check.
• The Fed has not given up on its core intent of keeping monetary policy “sufficiently restrictive” to curb inflation. That means; growth considerations or even cost of funds will not be the driving factor, even though recent reports do suggest that higher rates have been impacting US household budgets and has hit housing demand badly.
• The Fed is likely to maintain the benchmark rates at the level of 5.25% and 5.50% till September, which is when the first possibility of a rate hike has been indicated. That means, the Fed meetings in June and July will only reiterate the current stance and use the interim period to analyse the data points like CPI inflation, PCE inflation and jobs.
• Even the September rate cut is not exactly a certainty. There is a good 60% probability that the rates will be cut by 25 bps in September, which means there is still a 40% chance of the rates being in status quo after the September meet too. Of course, this will entirely depend on how inflation pans out between now and September 2024.
• The FOMC members did express concerns over the high frequency MOM (month on month) inflation. For example, while yoy inflation was down 10 bps to 3.4% in April 2024, the headline inflation on MOM basis was actually up from 0.3% to 0.4%. Even the core CPI inflation MOM rose from 0.3% to 0.4%, showing short term pressures.
• The gist of the Fed May 2024 minutes is that at the current juncture, the Fed members lack the confidence to implement a rate cut. They would prefer to wait and watch if inflation really shows traction in moving towards the 2% mark. In the last 6 months, the headline inflation has gone nowhere and the pressures have been on the balance.

Rate cuts are off the table for now. The Fed wants to see tangible progress towards 2% inflation. A lot will depend on how the Fed defines tangible progress on inflation.

FED MINUTES AND THE IMPACT ON CME FEDWATCH

The table below captures the rate cut probabilities over the next 10 Fed meetings, based on the implied probabilities in the Fed futures trading.

Fed Meet	300-325	325-350	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550
Jun-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	Nil	4.2%	95.8%
Jul-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	0.6%	17.4%	82.0%
Sep-24	Nil	Nil	Nil	Nil	Nil	Nil	0.3%	9.0%	49.7%	41.0%
Nov-24	Nil	Nil	Nil	Nil	Nil	0.1%	2.8%	20.8%	47.2%	29.1%
Dec-24	Nil	Nil	Nil	Nil	Nil	1.6%	12.8%	35.4%	37.2%	13.0%
Jan-25	Nil	Nil	Nil	Nil	0.6%	5.8%	21.3%	36.1%	28.1%	8.1%
Mar-25	Nil	Nil	Nil	0.3%	3.3%	13.7%	28.7%	31.9%	18.0%	4.1%
Apr-25	Nil	Nil	0.1%	1.4%	7.0%	19.0%	29.8%	27.0%	13.1%	2.6%
Jun-25	Nil	0.1%	0.8%	4.2%	13.0%	24.5%	28.4%	20.0%	7.8%	1.3%
Jul-25	Nil	0.3%	2.1%	7.7%	17.6%	26.1%	25.1%	15.1%	5.2%	0.8%

Data source: CME Fedwatch

Actually, there is now an element predictability in the Fed minutes, so there is not much change in the CME Fedwatch probabilities since the Fed minutes made public in April 2024.

• Post the consumer inflation reading and the Fed minutes, the CME Fedwatch is assigning 50% probability to 2 rate cuts in the year 2024 with a probability of just 14% to 3 rate cuts by end of 2024. By the end of 2024, there is an 87% probability that there would at least be one rate cuts implemented by the Fed.
• The broad structure of probabilities have not changed much in the last 2 months. The expectation continue to be that the first rate cut will happen in September and there would be 2 rate cuts in 2024. In addition, the CME Fedwatch is pegging 2 more rate cuts by middle of 2025, by when the Fed rates would be in the range of 4.25% to 4.50%.

Having seen the market impact of the minutes on the CME Fedwatch, let us turn to what is the real story emerging from the Fed minutes.

READING BETWEEN THE LINES OF THE MAY 2024 FED MINUTES

One thing is clear from the minutes that the overriding concern for Fed officials is the inflation level. As of April, the headline consumer inflation is 140 bps away from the 2% target and that is long journey. Also, as the Fed had cautioned, the last mile is proving to be a lot more complicated in terms of managing policy. Here is what we interpreted from the FOMC minutes published on May 22, 2024.

• The consensus among the FOMC members seems to be that the inflation had eased over the past year. However, the committee has also expressed concerns that inflation had been erratic in a range in the last few months and the last mile was proving to be unpredictable. This had made it tough for the Fed to provide any kind of guidance on the trajectory of rate cuts, although it was on the agenda.
• There were some voices to be prepared to tighten policy, although it looks unlikely after inflation has remained in a range despite the Fed not increasing rates since July last year. The consensus, as articulated by Jerome Powell, is that to control the occasional upward drifts in inflation, holding rates higher for longer would suffice. Powell underlined that inflation spike in 2024 had been due to events in the Middle East and West Asia.
• Interestingly, Powell has not publicly changed his assurance of 3 rate cuts given in the previous Fed meeting. Even in a recent interview, Powell had indicated that 3 rate cuts in 2024 were still possible. However, nearly half the year out of the way, 3 rate cuts in 2024 is looking increasingly impractical. A more believable estimate will be 2 rate cuts.
• Majority of the FOMC members were apprehensive to even talk about rate cuts till inflation normalized from the current levels. The general feeling was that it was too premature to offer any guidance on the quantum and number of rate cuts in this year, although the market is pencilling rate cuts to commence by September 2024.
• There were also concerns that too much of the recent fall in inflation since the peak of 2022 was driven by a natural tapering of core inflation as supply chains normalized. However, that appears to be saturating and FOMC members believe there is only so much more than core inflation can contribute. That means; going ahead, inflation would be at the mercy of the vagaries of food and fuel prices.
• The outlook for GDP growth continues to be robust with the Atlanta Fed GDP estimate pegging GDP growth at closer to 3.6%. That kind of growth was never going to be in sync with 2% inflation and that is evident from the fact that consumer spending has continued to be robust. Now the Michigan Consumer Sentiment Survey has pegged inflation expectations at 3.5% for the year, making it a sticky challenge.
• The FOMC members have underlined some key upside risks to inflation including geopolitical and the strong demand for oil. The Fed is also very sensitive to the inflation issue since it is known to hit the vulnerable sections much harder. The minutes also noted that consumer were resorting to riskier forms of financing amidst inflation pressures. That is a catch-22 since that has also been caused partially by higher rates.
• Governor Waller summed it best when he said, “We have to see weeks of supportive data to even consider rate cuts.” While the CME Fedwatch is hinting at rate cuts starting in September, the probability is around 50%, which means it is more like the flip of a coin. The conviction to embark on rate cuts is still missing.

The message appears to be quite clear from the minutes of the Fed meeting. The FOMC will eventually move on rate cuts. But it is hard to say when and whether it will happen. The US economy has long thrived on near-zero rates. Now, the reverse situation is back to haunt the policymakers. Rate cuts still look like they may go down to the wire.

HOW WILL RBI INTERPRET THE FED MAY-24 MINUTES?

It may be recollected that the RBI had implemented its last rate hike in February 2023 and has since held rates static for the next 7 meetings. However, pressure may be building up on the RBI to curb inflation and also bring down rates. High inflation and high rates of interest may offset some of the big gains that the government has scored in controlling the fiscal deficit and also in keeping borrowing costs under check. IN April 2024, India consumer inflation fell by 2 bps to 4.83%. However, there are concerns over what could happen if the Red Sea crisis worsened and imported inflation became a real problem to contend with.

Like in the past, the RBI is likely to be pre-emptive on rate cuts. We must not forget that the repo rates at 6.50% are a full 135 bps above pre-COVID levels. Also, if you look at the 10-year benchmark bond yields around 7.00%, the real rate is over 2%; which is unsustainable. While the Fed has not committed anything in the minutes, the CME Fedwatch is pegging the first rate cut only in September 2024. India should hopefully see a stable government at the centre, which has also presented the full budget for FY25. RBI will eventually have to cut rates to avoid stress on corporate balance sheets.