Fed minutes not so hawkish

Goldman with the note. No 50bps hike there.

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BOTTOM LINE: The January FOMC minutes indicated that participants judged that it would “soon be appropriate” to raise the federal funds rate, but “some” participants noted that “financial conditions might tighten unduly” in response to rapid monetary policy tightening, suggesting a 50bp hike in March is less likely. Regarding balance sheet plans, participants generally noted that “a faster pace” and “significant” reduction would be appropriate, but specific details were limited, suggesting that the Committee intends to complete their discussion at upcoming meetings before indicating their intentions. Participants cited “inflationary wage-price dynamics” as one upside risk to inflation, though they continued to expect inflation to moderate over the course of the year.

MAIN POINTS:

1. In light of elevated inflation pressures and a strong labor market, participants judged that it would “soon be appropriate” to raise the federal funds rate, and “most” participants suggested that the pace of hiking should be faster than last cycle. “Most” participants agreed that it would be appropriate for the FOMC to remove accommodation faster than they anticipate “if inflation does not move down as they expect,” but “some” participants noted that “financial conditions might tighten unduly” in response to a rapid removal of policy accommodation. In response, “a few” participants argued that the risks of a disorderly tightening of financial conditions could be mitigated “through clear and effective communication” of the Committee’s views. We continue to expect liftoff in March and seven hikes in2022.

2. The minutes noted that participants discussed balance sheet runoff but that details on timing and pace would be determined at upcoming meetings. Participants generally noted that current conditions “warrant a faster pace” of reduction than last cycle and that a “significant reduction” of the balance sheet would be appropriate. Additionally, “many” participants commented that sales of agency MBS or reinvestment of MBS principal payments into Treasuries may be appropriate to adjust the portfolio composition at some point in the future. In our view, the lack of specific details on the FOMC’s balance sheet reduction plans most likely signals that the Committee intends to complete their discussion before indicating theirintentions.

3. Inflation readings continued to “significantly exceed” participant forecasts, and some participants noted that elevated inflation “had broadened.” While participants generally expected inflation to moderate in 2022, they agreed that uncertainty was elevated and that risks were skewed to the upside. Participants cited “inflationary wage–price dynamics” and the possibility of “unanchored” longer-term inflation expectations among these upside risks. The staff revised its near-term inflation forecast higher and saw risks to its inflation projection skewed to the upside.

4. The Fed staff’s forecast for economic growth was “weaker” than at the December meeting, reflecting the rapid spread of Omicron and a slower-than-previously-assumed resolution of supply-chain disruptions. The staff forecasted GDP growth “roughly in line” with potential in 2023 and 2024, but noted that it expected the level of GDP to remain“well above potential” through 2024. While “participants” noted that Omicron would weigh on economic activity in Q1, they “concurred” that economic activity would “strengthen rapidly” and growth for 2022 as a whole would be “robust” if virus spread slowed rapidly.

5. Following a staff briefing on financial stability, in which vulnerabilities were characterized as “notable,” committee members discussed several possible risks, including the rapid growth in crypto-assets (which “some” participants saw as an emerging risk); the vulnerabilities of prime money market funds and prevalence of highly leveraged, nonbank financial institutions (“a few”); and elevated asset valuations across a range of markets (“a few”, though “a couple” participants pushed back).

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