The Fed minutes are here. 4 key themes to watch.

The minutes of the Federal Reserve’s May meeting can be read here. Read a preview below and check back for more analysis.

When the Federal Reserve releases the minutes of its latest policy meeting on Wednesday, investors will get a deeper look at deliberations on monetary policy tightening and officials’ views on the economy.

During the meeting that ended May 4, the Federal Open Market Committee, the policy arm of the Fed, raised its key interest rate by 0.5%. It was the first hike of this magnitude since 2000. Authorities signaled a similar increase in June, and Wall Street expects another 0.5% rate hike in July. But what happens after the June 14-15 meeting is less certain and will depend on the path of inflation, economic growth and financial conditions.

Here are some things to watch in this week’s minutes and central bankers’ comments ahead of the next policy meeting and beyond.

Financial conditions

When Fed officials and economists talk about “financial conditions,” they’re referring to things like stock market levels and corporate bond spreads. These are some of the transmission mechanisms of monetary policy, affecting households and businesses through the wealth effect and the cost of credit.

Since the last Fed meeting, financial conditions have tightened significantly. Investors are looking for clues as to how far the central bank would like stocks to fall and credit spreads to widen. Deutsche Bank economists note that during his post-meeting press conference last month, Fed Chairman Jerome Powell mentioned “financial conditions” 16 times, indicating the topic was at the center of the meeting.

“Powell and his colleagues have demonstrated that they are increasingly focusing on tighter financial conditions in place of providing more forceful guidance on whether the federal funds rate will need to reach a restrictive level over time. time,” Deutsche Bank economists say, meaning financial conditions are critical. to predict how high rates will go and when they might start to reverse. Economists there and elsewhere say the Fed likely wants financial conditions to continue to tighten, at least for now, given the high level of inflation.

For context, economists at Goldman Sachs say their GS US Financial Conditions Index has tightened about 0.6% to 99.29 over the past week. About a month ago, the metric stood at 98.64; at the start of the year it was around 97.

Inflation

While financial conditions are tightening, inflation is still at its highest level in four decades. The consumer price index rose 8.3% in April from a year earlier, largely thwarting expectations of an inflation spike. Although there are signs of easing pressures on property prices, housing inflation is stubborn and rising, the costs of basic necessities are high and the prices of services are rising.

“With falling stock markets and wider credit spreads, the US central bank is certainly getting what it wanted,” says Katie Nixon, chief investment officer of Northern Trust Wealth Management. “When we’ve seen these conditions in the past, the speed of these moves prompted the Fed to back out of well-laid plans to tighten policy,” she says. But the Fed is unlikely to change course now, given how far it has lagged the inflation curve, Nixon said. “The Fed has identified inflation as public enemy number one and risks a credibility crisis if policy is changed at this point,” hinting at the idea that dramatic market declines won’t trigger the so easily -saying Fed put this time.

In its May policy statement, the Fed said inflation risks were on the rise, given food and energy shortages stemming from the Russian invasion of Ukraine and Covid-related lockdowns in China that have exacerbated supply chain disruptions.

In a May 17 appearance, Powell said he wanted “clear and convincing evidence” that inflation was falling before slowing the pace of rate hikes. That’s legalese for the second-highest standard of proof and requires the proof to be highly probable, says Joseph Wang, a former senior trader in the Fed’s Open Markets Office and an attorney. Traders will be looking for any changes in language and tone around the expected path of inflation and risks for the Fed forecast, which will then be updated in June.

Slowed growth and soft or soft landing

Powell argued that the Fed could stage a soft landing, meaning growth would continue as the central bank tightens monetary policy to fight inflation, and Wall Street generally agrees. This assertion, however, has led some market participants to doubt that the Fed is being tough enough on inflation, setting up a stagflationary dynamic of slowing growth and high prices.

Recently, Powell’s tone has changed. He first used the word ‘soft’ instead of ‘soft’, then last week he said getting inflation under control could lead to a ‘bumpy’ landing. “There could be pain,” he warned.

The Fed’s May statement acknowledged the surprise drop in gross domestic product in the first quarter from the previous quarter, but said household spending and business fixed investment remained strong. Recent earnings reports from America’s largest retailers have challenged the prevailing narrative that because consumers – about 70% of GDP – have amassed trillions in savings during the pandemic, they will thwart the economy in the sense off from falling into a recession. However, the labor market is very tight. Economists expect the jobless rate to fall to 3.5% when May data is released on June 3. It would match the half-century low hit before the pandemic and it suggests wage pressure won’t ease anytime soon as employers struggle to find workers, although there are signs of increased layoffs .

Meanwhile, rapidly rising mortgage rates are dampening demand for homes, but prices continue to rise because there isn’t enough inventory. Rents are about a year behind house prices and housing accounts for about a third of the CPI, meaning upward pressure from this category will be hard to combat.

How the Fed views these cross-currents will be key in predicting how aggressive policy tightening will continue in the months ahead, especially as the central bank begins to shrink its balance sheet.

Potential MBS sales

The Fed said it would begin reducing its balance sheet by $9 trillion starting June 1, when it would no longer reinvest proceeds up to $3 billion in maturing Treasury securities and until ‘at $17.5 billion in mortgage-backed securities per month. Those caps are due to increase to $60 billion and $35 billion, respectively, in September.

But some officials have suggested they will need to become more aggressive in trying to partially unwind the quantitative easing, or pandemic bond purchases, of the past two years, particularly as they relate to the housing market. It will be particularly difficult to reduce its $3 trillion holding of MBS, given that prepayments, driven by refinancing activity, all but come to a halt as rates rise and the natural rolloff is therefore slow. .

Minutes from the Fed’s March meeting showed officials discussed the potential need to sell MBS outright. Citi economists note that recent Fed speeches suggest the topic may not have been “discussed forcefully” at the last meeting, so any indication to the contrary would represent a hawkish surprise.

Write to Lisa Beilfuss at [email protected]

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