Fed Minutes: A rate hike in June

» The Federal Reserve is planning to raise the fed funds target rate “soon“ (i.e. in June) – which would not come as a surprise to market actors;

» The pace of rate hikes will presumably not be accelerated even if inflation exceeds the 2% target for a certain length of time;

» The Federal Reserve is adhering to its gradual rate-hike trajectory  – the target range for the fed funds rate will probably be at 2%-2.25% towards the end of this year;

The minutes of the most recent FOMC meeting, which took place on 2nd May, were published yesterday. What was interesting for many market participants was to see how lively the discussion had been among the members of the Fed’s rate-setting committee about possible inflation risks, and whether the US monetary authorities are intent on increasing the pace of key-rate hikes in the event of mounting inflation pressure. Financial-market actors were also speculating whether Committee members had addressed the issue of yield-curve flattening. The minutes were scoured not least in search of clues as to whether the Fed will be tightening the monetary reins again in June.

It turns out that most FOMC members were indeed of the opinion that a further tightening step would soon be appropriate if incoming economic data largely confirm the current economic outlook. As to the trend in inflation, the latest minutes noted that a temporary period of inflation modestly above 2% would be consistent with the Committee’s symmetric inflation objective and could, furthermore, be helpful in anchoring longer-run inflation expectations. In addition, the minutes revealed that Committee members discussed the issue of yield-curve flattening. However, Committee members did not agree about the consequences of this development. A few members noted that various factors are making the yield curve a less reliable signal of future economic activity; others, on the other hand, demurred, pointing out the historical regularity that an inverted yield curve has indicated an increased risk of recession.

Although the latest set of minutes more or less explicitly holds out the prospect of a June rate hike, the tone of the transcript can nevertheless be interpreted as rhetorically moderate. In particular, the financial market construed the assurance that the Fed will not move onto a higher rate-hike trajectory if inflation quickens as being dovish. We are adhering to the assessment we have favoured for quite some time now, and are therefore expecting the FOMC to effect a further increase in the target range for the fed funds rate at its June meeting. All in all, the new transcript shows that the Fed is probably going to stay on its gradual rate-hike path. The implied probability, as inferred from fed funds futures, of at least two further tightening steps this year is currently 48%, with the implied likelihood of three or more further rate hikes standing at 52%. In view of the fact that mid-term elections to Congress are scheduled in the USA for November and that inflation should only be on a moderate path during the coming months, we expect one further interest-rate move this year following the June step.

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