November 2023 Fed minutes give no indication of rate cuts

22 Nov 2023 , 11:09 AM

Fed silent on rate cuts

On November 21, 2023, the Fed released the minutes of the Federal Open Markets Committee (FOMC) meeting. It may be recollected that the Fed had held the rates at the range of 5.25% to 5.50%. In the last 4 FOMC meetings, it had marked the third occasion when the Fed had held status quo on rates. This in sharp contrast to the aggression that the Fed has shown in hiking rates through most of 2022 and early 2023. For now, it looks like the Fed has reconciled itself to “Higher for Longer” philosophy. Rates will not be hiked too much, but they will be held at elevated levels for a longer period of time.

But the main point that came out from the Fed minutes turned out to be quite a disappointment for the markets. That was evident in the US bond yields falling to 4.41% and the dollar index also easing further to 103.55. The minutes were silent on rate cuts. That has been a major area of dichotomy. The Fed has been non-committal on rate cuts and has hinted at two possible rate cuts of 25 bps each by the end of 2024. However, the CME Fedwatch has been factoring in 5-6 rate cuts of 25 bps by end of 2024. Apparently, the optimism of the CME Fedwatch is not shared by the Fed minutes.

Why fourth quarter could be more challenging

In a sense, the third quarter was relatively comfortable for the US. Inflation was largely under control, barring some minor fluctuations due to oil prices. Labour market continues to be tight, although there has been some amount of demand contraction for labour too. So, it looks like tight labour market conditions cannot continue to create problems for inflation. Above all, what really worked for the Fed was the GDP growth. For the third quarter, the first estimate for GDP growth has come in at 4.9%. However, the bigger challenge for the US economy would be in the fourth quarter ending December 2023. Here is why.

Firstly, the cumulative impact of the tightening is likely to show on the growth in the fourth quarter, the Atlanta Fed is already pegging GDP growth in the fourth quarter at around 2.2%, which is much lower than the 4.9% being talked about for Q3. Also, the year-end festive shopping starting from Thanksgiving Day is likely to put pressure on inflation. That is why, the fourth quarter may post a bigger challenge for the Fed in terms of policy options.

CME Fedwatch and Fed view – How long can the dichotomy last?

One way to look at the Fed outlook from a market perspective is the CME Fedwatch, which captures probabilities of rate levels after each Fed meet over next 1 year. It is therefore the best market perspective of what the Fed is likely to do on rates over the next one year.

Fed Meet	350-375	375-400	400-425	425-450	450-475	475-500	500-525	525-550	550-575	575-600
Dec-23	Nil	Nil	Nil	Nil	Nil	Nil	Nil	95.0%	5.0%	Nil
Jan-24	Nil	Nil	Nil	Nil	Nil	Nil	Nil	93.0%	6.9%	0.1%
Mar-24	Nil	Nil	Nil	Nil	Nil	Nil	27.9%	67.2%	4.8%	0.1%
May-24	Nil	Nil	Nil	Nil	Nil	12.8%	45.9%	28.6%	2.6%	Nil
Jun-24	Nil	Nil	Nil	Nil	6.7%	30.1%	42.1%	19.8%	1.3%	Nil
Jul-24	Nil	Nil	Nil	3.8%	20.0%	36.9%	29.4%	9.3%	0.6%	Nil
Sep-24	Nil	Nil	2.4%	14.0%	30.7%	32.2%	16.7%	3.8%	0.2%	Nil
Nov-24	Nil	1.3%	8.8%	23.2%	31.5%	23.7%	9.6%	1.8%	0.1%	Nil
Dec-24	0.9%	6.6%	19.0%	29.1%	26.0%	13.7%	4.16.9%	0.6%	Nil	Nil

Data source: CME Fedwatch

What do we read from the CME Fedwatch probability shifts? Firstly, with the Fed rates already at the range of 5.25%-5.50%, another 25 bps hike this year almost looks like a worst case scenario; and that too with a fairly low probability in the next few months. While the Fed minutes have not spoken much about terminal rates, the CME Fedwatch has almost called an end to rate hikes. However, dichotomy between the Fed statement and what is manifested in the CME Fedwatch still continues. For example, the CME Fedwatch is hinting that rate hikes may be done and dusted for this round. However, the Fed has included enough safeguards in its minutes to indicate that rate hikes could happen again if the inflation spike left the Fed with no choice. Otherwise, higher for longer appears to be the narrative that the Fed has been hinting at.

The second dichotomy is on the rate cut front. The Fed is not willing to commit anything more than 50 bps rate cut by end of 2024. In fact, if you read the minutes of the November meeting, the Fed members have made no commitment on the likelihood or timing of rate cuts. That is something that the Fed members have not touched upon, indicating that it may still be too early to start debating rate cuts. Fed minutes indicate that, Fed rates would still average above 5% even by December 2024. That means a worst case rate cut of 25 bps to 50 bps by tend of 2024. On the contrary, the CME Fedwatch appears to be getting more aggressive on the possibility of rate cuts. It is pegging the Fed rates to go as low as 4.25% over the next one year. How were such dichotomies been addressed in the past? The Fed takes its communication very seriously and would refrain from making any forward looking statement it is not sure of. In the past, there have been several occasions when such differences have arisen, but eventually the CME Fedwatch view has relented and gravitated towards the Fed view. It may not be too different, this time too!

What we deciphered from the November 2023 Fed minutes

The Fed minutes published late on November 21, 2023, were silent on the subject of rate cuts while reiterating that future rate moves would be calibrated and well thought through. Here is what we interpreted from a reading of the November 2023 Fed minutes.

1. The appetite among the Fed members to cut rates is still very limited. No member of the FOMC has even remotely expressed any hint that rate cuts were on the anvil. This is in sharp contrast to what the CME Fedwatch is indicating. The only thing that the FOMC members have said is that they would carefully deliberate before any rate move. This applies to up moves and down moves. However, with inflation still 120 bps above the 2% long-term target, members avoided any discussion on rate cuts.

    

2. The minutes underline that the FOMC members want the monetary policy to be “restrictive” until data shows that inflation was on a convincing trek back to the central bank’s 2% goal. The gist of the minutes of the Fed in terms of the member consensus was that participants felt it was critical that the stance of monetary policy be kept sufficiently restrictive to return inflation to the 2% objective.

    

3. The important words in the minute of the FOMC meet is “proceed carefully” and that gives room for some optimism. Members of the FOMC have underlined that on the rates front the committee must be cautious without risking too much either on the upside or on the downside. In short, rate hikes and rate cuts would be decided base on the totality of information inflows and its implications for economic outlook and balance of risks.

    

4. Even as the CME Fedwatch continues to factor in 4-5 rate cuts by end of 2024, the Fed minutes show that members did not even take up rate cuts for a discussion. In fact, the minutes have not given any indication that members of the FOMC even discussed when they might start lowering rates, although Jerome Powell had hinted that in his interview.

    

5. Obviously, the last 6 weeks have seen a sharp spike in the 10-year bond yields in the US and that was the major topic of discussion. However, the Fed has been quite emphatic that the rising bond yields must not be construed as a signal that rates will rise further. On the contrary, this spike had been triggered by rising risk premiums. The longer term bonds were trading either at a yield equivalent to shorter term bonds and at times even at lower yields. That has corrected and normalized in the last few months and that is what explains the spike in yields.

    

6. There is a clear signal from the FOMC that the GDP growth could slow in the fourth quarter of 2023. The fall is likely to be 250-270 basis points compared to 4.9% in the third quarter. In short, the message from the FOMC minutes is that the risks to broader economic growth were skewed to the downside, even as the risks to inflation were largely skewed to the upside. The FOMC admitted that the current restrictive policy of the Fed was putting downward pressure on GDP growth and that was part of the plan.

    

7. Most members expressed the view that getting inflation lower from current levels may be tricky and, at best, gradual. That is because, the wage increases are still running strong and the more stubborn components like rent and medical care continue to stay elevated. In fact, the Fed even expects the core inflation to bounce back later this year. However, labour shows signs of tapering with non-farm payrolls increasing by just 150,000 in October; the slowest in recent memory. Even unemployment is expected to climb back to 3.9%, which the markets are hinting at a signal of recession. 

    

8. The minutes clearly underline that, “Further tightening of monetary policy would be appropriate if incoming information indicated that progress toward the Committee’s inflation objective was insufficient.” In short, even rate  hikes would be carefully calibrated by the FOMC members from here on. In short, the FOMC members are still wrestling with conflicting economic signals. The best thing to do when in doubt, is to push out. So, the Fed may just hold rates at the 5.25%-5.50% range for now.

    

9. The sentiments of the FOMC members can be summed up as cautiously hawkish. The minutes have put conditions around the need for further rate hikes and focusing more on how long the current policy rate may need to be maintained. At least, there is now a clear shift in the Fed narrative from hiking rates to holding rates. 

    

10. However, there was little appetite among the FOMC members to declare victory over inflation. This despite the fact that inflation is down sharply from peak levels of 9.2%. While critics have been vocal about the US starting rate hikes too long after inflation spiked, the FOMC is of the view that such a delay helped save the day. An early start to rate hikes would have had the same impact, but would have curtailed growth in a big way.  That would hardly have been a very delectable scenario.

To sum it up, the US policymakers and Fed officials can pat themselves in the back. They have managed to bring inflation largely under control, without the risk of impairing growth. The much feared hard landing has not happened. That is something worth savouring for the Federal Open Markets Committee (FOMC).

What do the Fed minutes imply for the RBI?

RBI effected its last rate hike in February 2023 and has kept rates on hold over the next 4 MPC meetings in April, June, August, and October 2023. December may also be a similar story. After the monsoons driven spike, inflation is back to near normal, so the RBI has less to worry about on the inflation front. Of course, that does not shield the RBI from more rate hikes, if the situation demanded. 

While RBI members in the MPC are still hawkish, the MPC overall is still ambivalent on whether it should hike rates. For now, a pause looks most as an answer. The Fed minutes will give RBI the leeway to pause in December also and that should take away any immediate concerns on the monetary policy front. For now, a pause in the US gives breathing room for the RBI. However, domestic inflation, rising global bond yields and a highly vulnerable Indian rupee are the X-factors.