Fed Minutes: Despite Encouraging July CPI, Inflation Remains Far Too High

FS Insight Team

It’s not time for a victory lap just yet, even after markets have rallied substantially since their June lows, and an encouraging July CPI print pushed them higher.

This week, the Fed released the minutes from its most recent policy meeting in late July. Fed officials, according to the minutes, think inflation remains too high, and are committed to raising rates. They’re almost certain to raise rates again when they meet next month.

Fed officials also saw trouble coming in housing. They said housing activity had “weakened notably,” in large part because of higher mortgage rates. Meeting participants “anticipated that this slowdown in housing activity would continue.” Many have predicted that the Fed’s efforts to slow inflation would crash housing prices, after a big run-up during the pandemic. And a housing bust might force the Fed to stop raising rates, perhaps before it was able to tame inflation.

In June, the central bank raised its benchmark interest rate three-quarters of a percentage point, the largest increase since 1994. They followed that up with another, equally large rate increase last month. It is widely expected that the Fed will raise rates again when officials meet next on Sept. 20-21. The question is by how much.

“Participants concurred that the pace of policy rate increases and the extent of future policy tightening would depend on the implications of incoming information for the economic outlook and risks to the outlook,” the minutes said.

But as of their July meeting, policymakers continued to express concern about rapid price increases.

“Participants agreed that there was little evidence to date that inflation pressures were subsiding,” according to the minutes. “They judged that inflation would respond to monetary policy tightening and the associated moderation in economic activity with a delay and would likely stay uncomfortably high for some time.”

The data released since the July meeting has sent conflicting signals. Consumer prices were roughly flat in July, and the year-on-year pace of inflation cooled. The housing market has slowed sharply, suggesting that higher borrowing costs are beginning to take a toll. On the other hand, hiring and wage growth remained strong in July, and consumers continue to spend, trends that, if they continue, could keep upward pressure on prices. Here’s the latest view from our Tom Lee, Head of Research:

“As the inflation data weakens and economic data softens, that makes the Fed’s job easier. I think in the second half we’re going to get quite a lot of P/E expansion and better earnings, that’s why I think all-time highs are possible,” Lee said this week.

Lee added: “Over the past nine months investors became convinced that inflation is with us for years, it’s very sticky, but it looks like inflation is proving to be a lot less sticky and maybe even more sensitive to gasoline falling because of how gasoline moves through the services CPI. If that’s correct, we’re moving more toward a soft-landing like 2018, and that would mean markets have already discounted much of the Fed tightening.”

“The word dovish and hawkish are words used by too many investors as like a binary fact,” Lee continued. “The Fed needs to raise rates. They’re at the neutral rate now. …You can look at many periods when the Fed was raising rates, and in that second half of a rate cycle, equities start to rally. That even happened in August 1982…This is about the Fed not trying to shock markets and deliver essentially a nuclear financial tightening. That’s what they were trying to accomplish earlier this year, that’s not the case anymore.”

The Fed will hold its annual Jackson Hole meeting next month. This meeting was originally set in that location because of Chairman Paul Volcker’s love for fly fishing. Their next policy meeting will be in September.

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