Mea Culpa Minutes

Minutes of the Fed’s June policy meeting, released on Wednesday, skewed hawkish.

That’s not terribly surprising. After all, the outcome of last month’s meeting was a 75bps rate hike, the largest since 1994. I called it a dramatic mea culpa.

The gathering was remarkable for the extent to which policymakers received information that changed the outcome during the pre-meeting quiet period. A red-hot CPI report followed by a disconcerting uptick in longer-term inflation expectations accompanying the preliminary read on June University of Michigan sentiment tipped the scales.

With just three business days to go before the meeting (and no scheduled speaking engagements due to the communications blackout), the Fed was forced to effectively leak their intention to deliver a 75bps increment via the media, starting with the Wall Street Journal‘s “Fed whisperer,” Nick Timiraos.

That context is important when it comes to playing tasseographer with the June minutes. The Fed was concerned. And “concerned” is probably the wrong adjective. Officials’ inflation consternation was reflected in the account of last month’s proceedings.

“Many participants judged that a significant risk now facing the Committee was that elevated inflation could become entrenched if the public began to question the resolve of the Committee to adjust the stance of policy as warranted,” the minutes said.

The Fed is now operating on what amounts to a single mandate, and not just because the employment side is satisfied. Virtually no level of unemployment (short of depression conditions) would be sufficient for the Fed to assign greater weight to jobs than headline CPI inflation when the latter is one (more) exogenous shock from double-digits.

Remember: We all suffer from recency bias, even when we’re old enough to remember times that aren’t so recent. 8.6% inflation feels just as wildly anomalous to Jerome Powell as it does to someone who wasn’t alive the last time inflation was anywhere near that hot. For what it’s worth, Powell was in his late 20s (figure below).

Even if inflation falls rapidly from here, the Powell Fed’s legacy will be defined by reference to one word: “Transitory.” That’s an unfortunate state of affairs, especially considering all Powell’s been through since 2018, but he made the one mistake you can’t make as Fed Chair. If you’re going to be wrong about inflation, and you’re going to do it loudly and publicly, you can’t be the Fed, especially not in an era when the public is disaffected, predisposed to derisive narratives about “the establishment” and distrust of government is endemic.

Rather than admit to operating with a single-minded focus on price stability even at the possible expense of a “few” jobs, the Fed is instead attempting to recast the inflation fight as not only consistent with, but in fact necessary for, cultivating a healthy labor market. Powell said as much during his press conference last month, and the point was reiterated in the minutes, which noted that, “a return of inflation to the 2% objective [is] necessary for creating conditions conducive to a sustainably strong labor market over time.”

There was no explicit commitment to 75bps at the July meeting, and the evolution of the macro mood (to say nothing of the data) since the June gathering may give some officials pause considering the impact of another 75bps increment would only be felt down the road, at which point the economy may be in a recession. In a short statement explaining her dissent last month, Esther George, a noted hawk, cautioned that “policy changes affect the economy with a lag, and significant and abrupt changes can be unsettling to households and small businesses as they make necessary adjustments.”

Still, George wasn’t arguing against aggressive tightening, or even against 75bps increments. Rather, she was arguing against unpredictable shifts in policy executed with no prior warning at delicate junctures. She was adamant about the necessity of removing accommodation quickly. She just wants to be deliberate about it instead of “abrupt.”

With that in mind, there was nothing in the minutes to suggest the Committee is inclined to soften its stance imminently. “Participants concurred that the economic outlook warranted moving to a restrictive stance of policy, and they recognized the possibility that an even more restrictive stance could be appropriate if elevated inflation pressures were to persist,” another key passage said. It was obvious that officials are prepared to countenance a slowdown.

Naturally, there was a bit of back-patting, despite how absurd that seems under the circumstances. “Many participants” said the Fed’s “credibility” along with communications in 2022 have “been helpful in shifting market expectations of future policy and [have] already contributed to a notable tightening of financial conditions that would likely help reduce inflation pressures by restraining aggregate demand.”

All of that’s true, it’s just that now probably isn’t the best time to make laudatory claims about oneself if you’re a monetary policymaker and inflation is quadruple your target.

To be fair, the minutes were just conveying the evolution of events as they occurred. The Fed’s hawkish pivot, which began in earnest late last year, alongside evolving expectations for policy, served to push real rates sharply higher prior to Russia’s invasion of Ukraine, with the effect of pulling equities and other risk assets lower. More recently, breakevens have come down, and since peaking around the June meeting, terminal rate pricing has receded materially alongside an increase in subjective recession probabilities.

That latter conjuncture could be construed as indicative of an imminent policy mistake, but for now, the Fed will (paradoxically and perversely) be inclined to read it as a vote of confidence. Something like this: “At least the market is still confident in our capacity to engineer a recession sufficiently deep to prevent us from realizing ‘peak dot’.” Only in the world of central bankers does that count as “credibility.”

A word search of the June minutes for “inflation” turns up 90 mentions. The word “recession” doesn’t come up a single time.