Fed officials agreed last month that even if it slows the US economy, interest rates may need to keep rising for longer to prevent high inflation from settling in. According to the minutes of the Federal Open Market Committee's June 14-15 policy meeting, Central bank members reiterated their tough stance on inflation, saying at the July 26-27 meeting that a 50 or 75 basis point move would be more appropriate. The document noted that policymakers acknowledge the possibility that an even more restrictive stance may be appropriate if high inflation pressures persist.

Many participants agreed that there was a significant risk the committee faced that high inflation could stabilize if the public began to question the committee's determination to adjust its policy stance as needed.

Officials also acknowledged that policy tightening could slow the pace of economic growth for a time, but they found that a return to 2% inflation was critical to achieving maximum employment on a sustainable basis.

In June, central bankers acknowledged the possibility that an even more restrictive stance might be appropriate if high inflation pressures persist.

Policy makers stated that "if inflation expectations remain stable, it will be more costly to return inflation to the committee's target".

Officials increased rates by 75 basis points in June to a target range of 1.5% to 1.75%, the highest since 1994, and Powell said they could do the same again in July, with policymakers met on July 26-27, he said a 75 basis point increase or 50 basis point move is most likely on the table. Although officials had previously signaled they were supporting a 50bps increase ahead of the June meeting blackout period, they made a larger increase in June after higher-than-expected inflation data and expectations for future price pressures among U.S. consumers accelerated.

Fed futures funds rate pricing… Source: Bloomberg, CME Fedwatch

The minutes of the June meeting look significant in revealing more details about the reasons for the move and the extent of support for another super-large rate hike among committee members. The personal consumption expenditures price index, which the Fed uses for its inflation target, has increased 6.3% since May 2021. This is more than three times the central bank's 2% target. Powell said there are ways to curb inflation while keeping the labor market strong, but acknowledged that it will be difficult. Details in the minutes show that policy makers are concerned about keeping inflation expectations stable. Most committee members seem to agree that a more front-loaded rate hike could prevent inflation expectations from rising further. More than one reference has to be evaluated on how high gasoline and food prices can affect the inflation psychology of households. Under this perspective, the Fed has to make more inferences not only on headline inflation-related variables, but also on core inflation indicators. The Fed can ensure policy effectiveness by making accurate determinations in terms of identifying the right source of inflation and using appropriate policy tools.

The Fed's aggressive pressure to curb the highest inflation in the last 40 years has rattled financial markets as investors fear that tighter monetary policy will plunge the US economy into recession. Growth forecasts have been lowered after the weak consumer spending in the US economy, tightening in financial conditions and data showing a decline in US manufacturing activity. Mortgage rates, which have doubled since the start of the year, are also cooling the housing market, with some businesses seeing lower demand. Since the June meeting, many officials have echoed Powell's forward-looking guidance on the likely outcome of the July rate decision, even as recession fears escalate.

Markets expect policymakers to raise interest rates another 75 basis points at the FOMC's meeting at the end of July. However, it is the direction and size of any economic surprise that will determine the size of the July interest rate hike. Since the June meeting, inflation and growth have been negatively surprised. All in all, the probability of a 75 basis point increase this month is still high, but not certain. A lot can still change in the next few weeks.

In the coming year, the probability of a recession in the US is higher than in the past. A similar perspective is seen on the side of market pricing in terms of interest rate futures: the expectation that the Fed will reverse course next year, stop rate hikes sooner than officials predict, and start lowering rates from mid-2023 has begun to come to the fore.

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