Fed shifts into cautious policy mode as risks become more two-sided

FOMC minutes: US Federal Reserve officials agreed at their last policy meeting that they would proceed "carefully" and only raise interest rates if progress in controlling inflation faltered, the minutes of the October 31-November 1 gathering showed on Tuesday. "All participants agreed that the Committee was in a position to proceed carefully," according to the minutes, which appeared to show support for more rate hikes dissipating within the US central bank's Federal Open Market Committee, and the baseline shifting to one in which its benchmark overnight interest rate remains steady absent a bad inflation surprise.

Inflation has been slowing - consumer prices did not rise at all on a month-to-month basis in October - and while the Fed has not declared its fight against rapid price increases over, the tenor of the discussion has been shifting towards a focus on how long to keep the policy rate in the current 5.25 per cent-5.50 per cent range.

"Participants noted that further tightening of monetary policy would be appropriate if incoming information indicated that progress toward the Committee's inflation objective was insufficient," said the minutes, a statement that indicated it will take an unexpected shock of some degree to prompt a further rate increase.

That sentence did not appear in the minutes of the Fed's prior meeting in September, when "a majority of participants" still judged that another rate increase would be needed in a tightening cycle that has pushed the policy rate 5.25 percentage points higher in the past 20 months.

The latest policy meeting readout, by contrast, said that "all participants judged it appropriate to maintain" the current rate setting, a stance that will be clarified at the Fed's Dec. 12-13 meeting when policymakers issue a new set of detailed projections for interest rates and the economy.

The document drew little reaction in financial markets, largely affirming the view that the Fed is done raising rates but won't explicitly say so until more officials become convinced inflation won't rebound.

Contracts tied to the federal funds rate continued to show a near-zero probability of further increases. Odds of a rate cut at the Fed's April 30-May 1, 2024 meeting rose slightly to roughly 60 per cent, from about 57 per cent before the release of the minutes, according to the CME Group's FedWatch Tool.

US stocks added slightly to losses and closed lower following the release of the minutes, while the US dollar (.DXY) edged higher against a basket of currencies. US Treasury yields slipped.

The minutes showed US central bank policymakers wrestling with conflicting economic signals that have made risks to the economy "more two-sided," with rekindled inflation still a concern, but worries as well about clamping down on credit too far and damaging the economy's prospects.

US economic growth had just registered an outsized 4.9 per cent annualized gain in the third quarter, a seemingly inflationary pace. But financial markets had driven interest rates higher for households, businesses and the US government, threatening to curb economic and job growth more than might be necessary to return inflation to the Fed's 2 per cent target.

"Participants commented on the significant tightening in financial conditions in recent months, driven by higher longer-term yields," the minutes said.

Still, inflation "remained well above" the central bank's target, likely requiring Fed policy "to remain at a restrictive stance for some time until inflation is clearly moving down sustainably."

"The overall tone of the FOMC minutes was cautiously hawkish - the commitment to remaining in restrictive territory for 'some time' was the clearest takeaway," said Ian Lyngen, strategist with BMO Capital Markets.

NO VICTORY DECLARATION

Fed Chair Jerome Powell had made liberal use of the "careful" concept at his last press conference in describing the central bank's efforts to balance still-elevated inflation with a sense the economy was about to slow.

There's good reason to be cautious, with the Fed possibly on the verge of pulling off the unexpected by navigating out of the worst inflationary surge in 40 years without doing major damage to the economy.

A New York Fed staff study released on Tuesday suggested in fact that the US central bank's late start in raising interest rates, with the first hike coming a year after prices began a sharp rise, allowed the economy to bank more growth with the same progress on lowering inflation than would have been the case if rate increases had started sooner.

There's little appetite among policymakers, however, to declare victory yet, or to give investors much direct guidance about what will happen next.

"Inflation has given us a few head fakes. If it becomes appropriate to tighten policy further, we will not hesitate to do so," Powell said at an International Monetary Fund research conference earlier this month. "We will continue to move carefully, however, allowing us to address both the risk of being misled by a few good months of data, and the risk of over-tightening."