The October CPI data, which influence or guide prices, inflation outlook and policy forecasts, the November FOMC meeting, the Covid measures in China that will shape the state of global demand and prices, or the temperature variables in Europe make the policy mix dependent on too many variables. For this reason, the possibility that the Fed will accelerate its “pivot” speech by evaluating the recent softening inflation sits on very contradictory ground. We are getting data showing flexible demand, and this front-loading demand and borrowing habit is not very positive in terms of future activity prospects. There’s also the risk that too many adjustments will stall the activity leg hard, as the US economy is overheating and the Fed needs to do more to cool the demand component of inflation. Global recession expectations for 2023 are quite intense, with the US on the “more moderate” side of this equation. While the possible damage effect of the frontal overload prompted the Fed to downshift in December, the “cooling of demand” efforts against inflation caused the “policy ceiling rate” expectation to not be lowered.
Ultimately, whether the landing will be hard or soft depends on how the Fed interprets the data. If Fed officials interpret recent strong demand indicators to indicate that interest rates are not restrictive enough, we will conclude that the walking cycle will take longer. The FOMC minutes will likely reveal that many on the committee did not share the market’s assessment that inflation was falling, but rather that they saw no significant signs of inflation cooling.
The LEI diffusion index continues to signal a strong recession… Source: The Conference Board, NBER Business Cycle Dating Committee
In terms of inflation outlook; Fed policymakers have raised their inflation forecasts since the September meeting as CPI and PCE data came in higher than expected. Fed members also predict that the output gap will not close until after 2025, which will mean higher inflation over the entire forecast horizon. “Some” policymakers may refer to evidence that wage growth has peaked and the labor market is beginning to soften. Others may have said that the labor market is still too tight. Two issues that probably dominate the discussion are the merits of more gradual rate increases and which rate levels constitute constraining territory. There may be general agreement that since monetary policy works laggedly, it is not appropriate to raise interest rates in 75 basis point increments continuously and that too rapid an increase could trigger financial accidents.
There will likely be less agreement on whether rates are already in the restrictive zone. Some FOMC members think so, citing the sharp adjustment in the housing sector and international rebound effects. Others, who talk about resilient household spending and high inflation expectations, do not.
There may be signs of increasing divisions in the committee. What makes next year’s rate path so uncertain is that there is a small but growing faction in the FOMC – led by Fed Vice Chair Lael Brainard, one of the most dovish committee members – that is more concerned about the reverse than the risks of over-tightening by the Fed. This group still believes that inflation is largely temporary and is more concerned about the employment outlook. The other group, including Powell, believes that inflation is more persistent and that the Fed still has a long way to go on rates. As can be seen, the views of the Fed chairman and vice chair also differ. As economic conditions deteriorate, this disparity may come into question more and more. The comments of these groups in the minutes are the facts that will affect the expectation of a Fed pivot next year. The over-tightening debate raises questions about policy makers’ determination to continue raising interest rates in the face of economic troubles, with the unemployment rate at 3.7% and inflation at 7.7% – far from the Fed’s target.
So far this year, FOMC committee members have been remarkably united in setting monetary policy. The November minutes will reveal a consensus among policymakers that the Fed should slow rate hikes, but there will be less agreement on the endpoint. Doves are concerned about the risk of over-tightening by the Fed – echoing the prevailing view in the markets – and the minutes will reveal how widespread this view is. This could provide a clue as to how quickly the Fed will bounce back when economic conditions worsen. A “few” attendees at the November meeting probably predicted a higher final rate, probably around 5%, than when they met in September.
As a result, the November meeting saw a compromise between doves and hawks — those more concerned about the risk of over-tightening pressed for the inclusion of the language of “cumulative tightening” in the policy statement, while Powell signaled a higher endpoint.
Kaynak: Tera Yatırım- Enver Erkan
