10 Key takeaways from the minutes of the December Fed meet

On 04th January 2023, the US Federal Reserve published the minutes of the last Fed meet of 2022 conducted in mid-December. The Fed practice is to publish the minutes of the Fed meeting exactly 21 days after the Fed statement. The minutes of the Fed meeting are important as they capture the gist of the discussions of the FOMC members in elaborate detail. There were 2 thing that emerged from the Fed minutes. To begin with, Fed members are almost unanimous about the fact that the pace of rate hikes had to slow down now. On the other hand, members felt it may still be too early to call a top on rates unless there is visible clarity that inflation was headed lower. That is still missing.

Before we go to the key takeaways from the Fed meet, let us quickly look at what the CME Fedwatch is suggesting. The CME Fedwatch pegs future rate probabilities over the next one year. These probabilities are market driven and derived from the Fed futures trading prices. The assumption is that the Fed futures prices fairly reflect the trajectory of rates. Between the Fed statement and the minutes of the December meet, there is greater confidence that inflation will stay higher for longer. Also, there seems to be a virtual consensus that rate cuts may not happen in 2023 and any such action was only conceivable in the year 2024. The tilt has been slightly more hawkish since the Fed statement, 21 days ago.

10 key takeaways from the Fed minutes

Here are the 10 key takeaways from the Fed minutes, including what the Fed minutes imply for the Indian markets and for the RBI rates trajectory.

1. First and foremost, the members of the FOMC (Federal Open Markets Committee) are almost unanimous that higher rates would stay around for some more time until visible progress was made in bringing inflation down. Forget about reversal of the rate cycle, even the topping out of the rate cycle could happen at best by the latter part of 2023.
    

2. One thing that members of the FOMC have agreed on is that rate hikes should be less aggressive from here on. That means; future rates could be in the range of 25 bps each. Overall, the guidance is for a minimum rate hike of 75 bps (mostly in 3 tranches) and a worst-case scenario of another 25 basis points hike.
    

3. At what level of inflation would the Fed call it quits? The FOMC is clear that members need not wait till inflation falls all the way to 2%. What the members would expect is that the incoming data to provides adequate confidence and reassurance that inflation was on a sustained downward glide path.
    

4. What the Fed is worried about, and as ratified by the members, is that the Fed should not embark on policy loosening too early. That would not only offset the efforts of the last one year but it would also make rate hikes as an instrument of inflation control, less effective in the future. That is why the Fed is progressing more carefully.
    

5. There is an accent on relying on data rather than on giving any guidance. That is the way it should be. Select parameters like the future trajectory of inflation, GDP growth, consumption patterns and labour data would have a bearing on the future trajectory of interest rates in the US. Rate cuts are already ruled out in the year 2023.
    

6. Fed has also been tapering its balance sheet, although that has not attracted as many eyeballs as the rate trajectory. Between June 2022 and December 2022, the Fed managed to wind down its asset holdings from $9.0 trillion to $8.6 trillion. This has helped to accentuate the impact of rate hikes on inflation.
    

7. One big challenge for the Fed has been the robust labour data, although it is hard to fathom whether it is positive or negative. According to the Fed minutes, job openings in the US are twice that of available workers. The outcome is that wages remain high and hence purchasing power has stayed robust.
    

8. How will the Fed minutes have an impact on FPI flows into India. Remember, the US Fed has tapered the bond book from $9 trillion to $8.6 trillion. In 2022, FPIs had been net sellers so the full impact of the winding down on passive flows was not exactly visible. However, in 2023, the winding down could hit passive flows.
    

9. One thing that emerges from the minutes is that the Fed is not yet done with rate hikes. RBI cannot confidently shift to a pro-growth stance and shift out of inflation control, as MPC members like Ashima Goyal and Jayanth Varma have been suggesting. RBI would have to be less committal and more data driven.
    

10. Lastly, if the general consensus of sustained hawkishness in 2023 is true, then there is a high probability of the US, UK and EU seeing a distinct slowdown or even dipping into recession. The inverted US yield curve has been hinting at that possibility for a long time. If that happens, it would be a challenge for the Indian economy as it would hit the US merchandise exports on the one hand and also hit IT sector volumes and pricing on the other hand. Clearly, Fed minutes have narrowed the options for India and the RBI.