Good afternoon Superstonk, let's dig into the minutes of the Federal Open Market Committee, June 13-14, 2023. This is a huge post so it will run into the comments but I am including a tldr to go with each section. The post itself has the main 'TLDRS' down below.
Developments in Financial Markets and Open Market Operations
The manager turned first to a review of developments in financial markets. Policy-sensitive rates increased over the intermeeting period, reflecting indications of continued resilience in the economy, persistently elevated core inflation, and reduced downside tail risks following the resolution of the debt limit. The shift in policy expectations contributed significantly to higher Treasury yields. The increase in nominal yields primarily reflected higher real rates rather than inflation compensation. Broad equity prices rose, although the outperformance was concentrated in a handful of companies with a large market capitalization. Cyclical sectors fared better than sectors that tend to appreciate in a downturn, suggesting some reduced investor concern about downside risks to growth. Investor sentiment about the banking sector improved as perceived tail risks regarding regional banks appeared to have receded. Equity prices for regional banks rose over the intermeeting period but were still well below early March levels. Financial conditions indexes were roughly unchanged, as higher rates and a stronger dollar were offset by higher equity prices and narrower credit spreads.
The vast majority of respondents to the Open Market Desk's Surveys of Primary Dealers and Market Participants expected no rate change at this meeting. While the median path from the surveys pointed to no rate changes through early 2024, there was significant dispersion across respondents, and respondents saw a clear probability of additional tightening at coming meetings. Respondents' average probability distribution for the level of the peak policy rate shifted higher since the May meeting and respondents on average assigned about 60 percent probability to the peak being above the current target range. The market-implied path for the policy rate continued to show some decline this year but less so than it had in recent months. Measures of uncertainty about the path of the policy rate derived from options remained very elevated, though they came down some over the intermeeting period.
Desk survey respondents still saw a recession occurring in the near term as quite likely, but the expected timing was again pushed later, as economic data pointed to the continued resilience of economic activity. Overall, respondents generally continued to expect that any downturn would be neither deep nor prolonged. With regard to inflation expectations, respondents marked up their projections for quarterly core personal consumption expenditures (PCE) inflation in the second and third quarters of this year, while projections for later quarters were little changed.
The manager then turned to money market developments and policy implementation. The median respondent to the Desk surveys expected the three-month bill yield to increase slightly relative to the similar-maturity overnight index swap (OIS) rate and to remain above it into the fourth quarter. This expectation likely reflected a combination of rising net supply of bills as part of the Treasury Department's plan to rebuild the Treasury General Account (TGA) following the resolution of the debt limit and expectations for healthy investor demand for bills. The overnight reverse repurchase agreement (ON RRP) facility, which continued to support effective policy implementation and control over the federal funds rate, saw somewhat lower participation since the resolution of the debt limit, consistent with the historical experience that ON RRP participation is typically responsive to changes in money market conditions. The median respondent to the Desk's Survey of Primary Dealers expected ON RRP participation to trend lower over the rest of this year. The staff assessed that the replenishment of the TGA and the ongoing balance sheet runoff, among other factors, were likely to subtract from reserves more than the decline in ON RRP participation would add to them. On net, the staff judged that reserves at the end of the year were likely to remain abundant. Uncertainty surrounding the outlooks for both reserves and ON RRP participation was substantial.
By unanimous vote, the Committee ratified the Desk's domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System's account during the intermeeting period.
- Policy-sensitive rates increased, due to continued resilience in the economy, high core inflation, and reduced downside risks following the resolution of the debt limit.
- Nominal Treasury yields increased mostly because of higher real rates, not inflation compensation. Equity prices rose, especially for larger companies and sectors expected to perform well in an economic upturn.
- Market expectations were generally for no rate change at this meeting, though there was a lot of disagreement among respondents. Future rate increases were seen as possible, and the market-implied path for the policy rate showed some decline.
- Respondents still saw a near-term recession as quite likely, but they expected any downturn to be neither deep nor prolonged. Inflation expectations for the second and third quarters of this year were raised.
- Money market developments included expectations of a slight increase in the three-month bill yield relative to the similar-maturity overnight index swap (OIS) rate. The ON RRP facility continued to support policy implementation and control over the federal funds rate.
- The replenishment of the Treasury General Account (TGA) and the ongoing balance sheet runoff were expected to reduce reserves more than the expected decline in ON RRP participation.
Staff Review of the Economic Situation
The information available at the time of the June 13–14 meeting suggested that real gross domestic product (GDP) was expanding at a modest pace in the second quarter. Labor market conditions remained tight in recent months, as job gains were robust and the unemployment rate was low. Consumer price inflation—as measured by the 12-month percent change in the price index for PCE—continued to be elevated in April.
Labor market conditions remained tight in April and May. Total nonfarm payroll employment increased at a robust pace during those two months. The unemployment rate edged up, on net, but was still at a low level of 3.7 percent in May. On balance, the unemployment rate for African Americans moved up to 5.6 percent, while the jobless rate for Hispanics moved down to 4.0 percent. In aggregate, the labor force participation rate held steady in April and May, and the employment-to-population ratio ticked down. The private-sector job openings rate in April—as measured by the Job Openings and Labor Turnover Survey—was unchanged from its relatively high first-quarter average, though it was lower than a year earlier.
Recent measures of nominal wage growth continued to be elevated, although lower than their highs last year. Over the 12 months ending in May, average hourly earnings for all employees increased 4.3 percent, below its peak of 5.9 percent early last year. Over the year ending in the first quarter, compensation per hour in the business sector increased 3.2 percent, down from 5.5 percent a year earlier.
Consumer price inflation remained elevated. Total PCE price inflation had eased since the middle of last year, reflecting declines in consumer energy prices and softening consumer food price inflation, but recent readings for core PCE price inflation—which excludes changes in consumer energy prices and most consumer food prices and usually provides a better signal about future inflation than the more volatile total inflation measure—were little changed. Total PCE price inflation was 4.4 percent over the 12 months ending in April, and core PCE price inflation was 4.7 percent—the same as the 12-month percent change recorded in January. In May, the 12-month change in the consumer price index (CPI) was 4.0 percent, and core CPI inflation was 5.3 percent—only slightly below its January reading. The trimmed mean measure of 12‑month PCE price inflation constructed by the Federal Reserve Bank of Dallas was 4.8 percent in April. Survey-based measures of longer-term inflation expectations in May from the University of Michigan Surveys of Consumers and the Federal Reserve Bank of New York's Survey of Consumer Expectations remained within the range of their values reported in the decade before the pandemic; near-term measures of inflation expectations from these surveys moved down in May and continued to be below their peaks seen last year.
Real GDP appeared to be increasing modestly in the second quarter following its stronger first-quarter gain. Private domestic final purchases (PDFP)—which includes PCE, residential investment, and business fixed investment and often provides a better signal of underlying economic momentum than GDP—looked to be expanding more slowly in the second quarter than its robust first-quarter pace. For the first half as a whole, PDFP growth seemed to be more resilient than in the second half of last year.
The annual revisions to international trade statistics suggested that net exports contributed positively to U.S. real GDP growth in the first quarter, with real exports rebounding more strongly than real imports following their fourth-quarter declines. In April, however, the nominal trade deficit widened notably, as nominal exports decreased and nominal imports rose further.
Foreign economic growth rebounded in the first quarter, reflecting in part the reopening of China's economy from its COVID-19-related shutdowns and strong services-sector activity in other Asian countries, Canada, and Mexico. In the euro area, however, real GDP contracted modestly for a second consecutive quarter amid a pullback in consumer spending. Indicators pointed to a step-down in the pace of foreign economic growth in the second quarter, with the impetus from China's reopening dissipating and global manufacturing activity remaining weak.
Global prices for energy and agricultural commodities were little changed, on net, over the intermeeting period, while prices for metals fell further. Declines in retail energy prices since the beginning of the year contributed to a notable easing in headline consumer price inflation in the foreign economies. By contrast, core inflation had yet to materially decline from its recent highs in many economies. In this context, and with tight labor market conditions, foreign central banks underscored the need to raise policy rates further or hold them at sufficiently restrictive levels to bring inflation back to their respective targets and be well positioned in case inflation failed to decline as expected.
- The US economy (real GDP) seemed to be growing at a modest pace in Q2 2023. Labor market conditions were tight, with robust job gains and a low unemployment rate.
- Wage growth measures were high but lower than last year's peaks. Inflation remained elevated with the total PCE price inflation at 4.4% and core PCE price inflation at 4.7% over 12 months ending in April.
- In the first half of 2023, private domestic final purchases (PDFP), including consumer spending, residential investment, and business fixed investment, appeared to be more resilient than in the second half of last year.
- US real GDP in Q1 was positively impacted by net exports, with real exports rebounding stronger than real imports. However, in April, the trade deficit widened as nominal exports decreased and imports rose.
- International growth rebounded in Q1, largely due to the reopening of China's economy post-COVID and strong service sector activity in Asia, Canada, and Mexico. But the pace of international growth appeared to be slowing down in Q2, with China's impetus dissipating and global manufacturing remaining weak.
- Foreign central banks signaled the need to either increase policy rates or maintain them at high levels to control inflation, as global prices for energy and agricultural commodities were steady, while prices for metals declined.
Staff Review of the Financial Situation
Over the intermeeting period, market participants appeared to interpret incoming data as signaling, on balance, more resilience in economic activity than previously assumed and viewed communications from FOMC participants overall as pointing to a tighter path for policy than expected. As a result, Treasury yields and the expected future path for the federal funds rate shifted upward significantly. Meanwhile, broad equity prices also increased notably. Financing conditions remained moderately restrictive, but credit availability generally remained solid.
The expected path of the policy rate implied by market quotes moved up notably over the intermeeting period. A straight read of federal funds futures rates suggested that market participants expected that the federal funds rate would be roughly flat over the course of the rest of this year. The year-end expected rate was about 70 basis points higher than the year-end expectation before the May FOMC meeting. Beyond this year, the policy rate path implied by OIS quotes also moved up, to about 3.7 percent by the end of 2024. Similarly, nominal Treasury yields rose significantly. The rise in nominal yields mostly reflected an increase in real yields, as measures of inflation compensation were little changed, on net, amid somewhat mixed news on inflation. Measures of uncertainty about the path of interest rates remained very elevated by historical standards.
The S&P 500 stock price index increased sizably, on net, over the intermeeting period, led by technology-related stocks. The VIX—the one-month option-implied volatility on the S&P 500 index—edged down, on balance, and ended the period near the 30th percentile of its historical distribution. Bank equity price indexes moved up notably, on net, over the intermeeting period. Stock prices for large banks were only somewhat below their levels before the failure of Silicon Valley Bank (SVB), while those for regional banks remained below their levels in early March.
Market-based policy rate expectations rose notably in most advanced foreign economies, as core inflation data surprised to the upside in some countries and central bank communications were perceived as pointing to more restrictive policy than expected. Notwithstanding the rise in global yields, foreign equity prices, credit spreads, and risk sentiment in foreign markets were little changed over the intermeeting period. The staff's trade-weighted broad dollar index was also little changed, on net, but the exchange value of the dollar appreciated significantly against the Chinese renminbi amid increased investor concerns over China's economic growth prospects.
Conditions in overnight bank funding and repurchase agreement markets remained generally stable over the intermeeting period. The 25 basis point increase in administered rates at the May FOMC meeting fully passed through to overnight money market rates. Spreads and issuance volumes in unsecured short-term funding markets stayed within their typical ranges. In May, yields of Treasury bills maturing in June and thus potentially affected by the federal debt limit rose sharply before largely retracing those increases after an agreement was reached to suspend the debt limit.
In domestic credit markets, borrowing costs for businesses, households, and municipalities increased notably over the intermeeting period. Interest rates on newly originated bank loans to businesses and households in the first quarter rose further above their peaks from the previous tightening cycle, and yields on leveraged loans also rose, reaching levels close to their peak at the onset of the pandemic. Rates also moved up on a broad array of fixed-income securities, including investment- and speculative-grade corporate bonds, municipal bonds, both agency and non-agency commercial mortgage-backed securities (CMBS), and agency residential mortgage-backed securities. The increases in yields on these instruments over the intermeeting period were generally in line with, or less than, the changes in their Treasury benchmarks. Small businesses and households saw continued increases in their borrowing costs. Rates on 30-year conforming residential mortgages stepped up, broadly in line with increases in comparable-duration Treasury yields. Interest rates on credit card offers continued to rise through April, and auto loan interest rates moved sideways during the intermeeting period. Both credit card and auto loan interest rates stood at, or near, their highest levels since the Global Financial Crisis.
Banks' ability to fund loans to businesses and consumers appeared to have stabilized in recent weeks but remained somewhat strained relative to before the closure of SVB in March. Although banks continued to experience outflows of core deposits, the pace of those outflows moderated substantially relative to March, suggesting some easing of bank funding pressures. Banks also continued to attract inflows of large time deposits, reflecting higher interest rates on new certificates of deposit. Total bank assets were little changed, on net, over the intermeeting period.
In capital markets, funding had generally been resilient. Issuance of nonfinancial investment-grade corporate bonds rose at a robust pace in May after slowing in April, partly due to the "earnings blackout" period. Speculative-grade issuance increased in late April and in May but remained subdued by historical standards. Gross issuance of municipal bonds was solid in April and May.
Conditions in the leveraged loan and CMBS markets were somewhat more strained. Leveraged loan issuance remained subdued, reflecting weak investor demand amid concerns over the credit worthiness of borrowers. Both agency and non-agency CMBS issuance volumes were low in May relative to pre-pandemic levels. In addition, for small businesses, credit availability continued to show signs of tightening.
Credit remained easily available in the residential mortgage market for high credit score borrowers who met standard conforming loan criteria. For borrowers with lower scores, credit availability tightened slightly in April but remained close to pre-pandemic levels. In consumer credit markets, conditions stayed generally accommodative, with credit available for most borrowers.
The credit quality of most businesses and households remained solid, although market participants appeared to expect some deterioration in the coming quarters, which could weaken lender balance sheets and possibly weigh on credit availability. A measure of the May CMBS delinquency rate showed about a 50 basis point increase, driven by a sharp rise in the delinquency rate for office buildings.
- The incoming data showed stronger economic resilience, leading to an increase in Treasury yields and expectations for future federal funds rate. As a result, equity prices also grew.
- Federal funds futures rates suggested a flat expectation for the remainder of the year, with the expected rate 70 basis points higher than the previous FOMC meeting. The market's implied policy rate rose to 3.7% by the end of 2024.
- The S&P 500 index increased significantly, led by technology-related stocks. Bank equity prices also rose, despite the failure of Silicon Valley Bank.
- In international markets, policy rate expectations also increased. Despite a rise in global yields, foreign equity prices, credit spreads, and risk sentiment were largely unchanged. The US dollar appreciated against the Chinese renminbi due to concerns over China's economic growth prospects.
- The financial situation remained generally stable, with a slight increase in borrowing costs for businesses, households, and municipalities.
- In domestic credit markets, interest rates on bank loans and leveraged loans rose. Rates on fixed-income securities also increased, but this rise was in line with or less than their Treasury benchmarks.
- In capital markets, nonfinancial investment-grade corporate bonds and municipal bonds saw strong issuance. However, leveraged loan and CMBS markets were somewhat strained.
- Credit remained easily available for high credit score borrowers, while tightening slightly for those with lower scores. Despite solid credit quality, participants expected some deterioration in the coming quarters, potentially impacting credit availability.
Staff Economic Outlook
The economic forecast prepared by the staff for the June FOMC meeting continued to assume that the effects of the expected further tightening in bank credit conditions, amid already tight financial conditions, would lead to a mild recession starting later this year, followed by a moderately paced recovery. Real GDP was projected to decelerate in the current quarter and the next one before declining modestly in both the fourth quarter of this year and first quarter of next year. Real GDP growth over 2024 and 2025 was projected to be below the staff's estimate of potential output growth. The unemployment rate was forecast to increase this year, peak next year, and remain near that level through 2025. Current tight resource utilization in both product and labor markets was forecast to ease, with the level of real output moving below the staff's estimate of potential output in 2025 and the unemployment rate rising above the staff's estimate of its natural rate at that time.
The staff's inflation forecast was little revised relative to the previous projection, and supply–demand imbalances in both goods markets and labor markets were still judged to be easing only slowly. On a four-quarter change basis, total PCE price inflation was projected to be 3.0 percent this year, with core inflation at 3.7 percent. Core goods inflation was forecast to move down further this year and then remain subdued. Housing services inflation was considered to have about peaked and was expected to move down over the rest of the year. Core nonhousing services inflation was projected to slow gradually as nominal wage growth eased further. Reflecting the effects of the easing in resource utilization over the projection, core inflation was forecast to slow through next year but remain moderately above 2 percent. With expected declines in consumer energy prices and further moderation in food price inflation, total inflation was projected to run below core inflation this year and the next. In 2025, both total and core PCE price inflation were expected to be close to 2 percent.
The staff continued to judge that uncertainty around the baseline projection was considerable and still viewed the risks as being influenced importantly by the potential macroeconomic implications of banking-sector developments, which could end up being more, or less, negative than assumed in the baseline. Given the continued strength in labor market conditions and the resilience of consumer spending, however, the staff saw the possibility of the economy continuing to grow slowly and avoiding a downturn as almost as likely as the mild‑recession baseline. On balance, the staff saw the risks around the baseline inflation forecast as tilted to the upside, as economic scenarios with higher inflation appeared more likely than scenarios with lower inflation and because inflation could continue to be more persistent than expected and inflation expectations could become unanchored after a long period of elevated inflation.
- The staff projected a mild recession to start later this year due to the expected further tightening of bank credit conditions amid already tight financial conditions. This was expected to be followed by a moderately paced recovery. Real GDP was projected to slow down in the next two quarters before declining modestly in the last quarter of this year and the first quarter of next year.
- The unemployment rate was predicted to increase this year, peak next year, and remain near that level through 2025. The staff also expected current tight resource utilization in both product and labor markets to ease.
- The inflation forecast remained largely unchanged, with total PCE price inflation expected to be 3.0% this year and core inflation at 3.7%. Inflation was expected to slow down but remain moderately above 2% through next year. By 2025, both total and core PCE price inflation were expected to be close to 2%.
- Uncertainty around the baseline projection remained significant, with risks greatly influenced by banking-sector developments. The staff saw the possibility of the economy continuing to grow slowly and avoiding a downturn as almost as likely as the mild-recession baseline.
- The risks around the baseline inflation forecast were seen as tilted to the upside. This is due to the possibility of scenarios with higher inflation being more likely, and the chance of inflation expectations becoming unanchored after a long period of elevated inflation.
- The Fed's monetary policy has remained accommodative
- The U.S. economy is projected to grow at a moderate pace, with inflation staying above the 2% target for a while longer due to supply chain disruptions and labor market tightness.
- Staff are still calling for a mild recession this year
- Despite inflation being above target, the FOMC members have decided to maintain the federal funds rate between 5 and 5-1/4 percent, citing the need for 'more data to better understand economic conditions'.