Fed Watch: FOMC minutes show policy flexibility, relief is relative

Relief has come in many forms, and last week’s relief rally following the Fed’s early May policy meeting reflected simple-minded investors who were bullish on bad news.

Meeting minutes show policymakers still flexiblesome even suggested the FOMC could adjust its program’s restrictive stance later this year.

Atlanta Fed President Rafael Bostic was among those urging caution, saying last week that a “pause” in rate hikes may be possible until September. In a colorful metaphor, he said that even a firetruck slows down at an intersection.

Fed reporters, faithful to their sources, trumpeted the policymakers’ tame determination in the headlines. There is no relief for these journalists, just believing that it will be so.

Federal Reserve Chairman Jerome Powell is cheering these efforts. He said earlier this month:

“This is not the time for an extremely nuanced reading of inflation. We need to see inflation come down in a convincing way. Until we do, we will move on.”

The index also eased in April, reaching its target of 4.9%, down from 5.2% in March.

The core PCE index, a measure of inflation used by policymakers, conveniently ignores food and energy prices because, by economists’ logic, these fluctuating prices don’t tell you where inflation is really headed.

However, one has to be fairly optimistic that inflation will slow significantly, whether in response to Fed action or for any other reason, no matter how you measure it.

An extremely tight labor market, soaring energy and food prices, and ongoing supply chain disruptions all point to inflation lingering for months.

On the one hand, Dr. Doom is not optimistic. Nouriel Roubini, who earned his nickname for his pessimism about the U.S. housing market in 2006, is also pessimistic about the possibility of a soft landing touted by Powell and his company in the current climate.in a article On Project Syndicate, Roubini wrote last week:

“The required level of monetary policy tightening will inevitably lead to a recession and a hard landing of rising unemployment. So a soft landing scenario looks like wishful thinking.”

One scenario Roubini thinks is likely is that once central bankers see the cost of actually lowering inflation, they will be “hands-on”. In this case, the result would be stagflation—high inflation and a recession with unanchored inflation expectations.

Diverging ECB policy paths

At the same time, the ECB signaled a marked divergence between the Fed’s policy path and that of the U.S. central bank, suggesting it won’t start shrinking its bond portfolio until next year.

No less than Klaas Knot, the super-hawkish governor of the Dutch central bank. Speaking at the World Economic Forum in Davos last week, he noted:

“That means we’re going to have a huge balance sheet for some time to come.”

Eurozone central banks are caught in a union-specific hybrid nature. There is a single currency and a single monetary policy, but 19 governments issue sovereign debt.

They all sold large amounts of bonds during the pandemic, and the ECB bought most of them. This is an easing measure that the central bank cannot easily withdraw without causing problems for weaker members of the region.

For example, Italy’s government debt is now 150%, while the EU has suspended the assumed cap of 60% for the third year in a row because it simply cannot be achieved.

That limits the ECB’s toolkit to rate hikes, and Nott is among those calling for a 0.5 percentage point hike in July. This is still an outlier, as July, September and December are widely expected to raise rates by 25 percentage points.

Euro zone interest rates have been cut to 7.4% in April from an initial 7.5%, but economists expect a new high of 7.7% in May, which will force the European Central Bank to act.