Federal Reserve Warns on Inflation
Minutes from the Fed’s Open Market Committee Indicate a Fear of Inflation
The minutes to the Federal Reserve’s June 12-13 meeting were released today. The June 12-13 meeting was one during which the Fed Funds rate was raised another quarter of a percentage point to 1.75% and indicate a Fed concerned about an economy with the potential to overheat. While the Federal Reserve noted that it expects to keep raising interest rates, such increase in rates may put a brake on economic growth. In addition, trade tensions may also cause a reduction in investment in the U.S. and abroad, further slowing growth.
The Fed is thus concerned about raising rates too slowly while the economy is experiencing accelerated growth that could lead to higher inflation causing a slow-down in the economy AND raising rates too quickly and putting the brakes on an accelerating economy causing a slow-down in the economy!
The minutes indicate that the Fed believes the economy is performing nicely with an expectations of 4% GDP growth in the second quarter. The Fed, however, is concerned that despite economic growth, it might not hit its inflation target of 2%.
The minutes also showed that the Fed removed boilerplate language that it would keep rates at lower levels to boost growth, indicating that it believed the economy had reached “escape velocity” and no longer needed monetary accommodation. The recent Trump tax cuts, however may provide a fair amount of fiscal stimulus as take home pay increases.
The key statement in the Fed June minutes was concern “that a prolonged period in which the economy operated beyond potential could give rise to heightened inflationary pressures or to financial imbalances that could lead eventually to a significant economic downturn”
From this statement, the Fed appears to be favoring to err on the side of a tighter policy and a majority of Fed members expect to keep raising rates to stave off inflation. This statement is forward looking because according to the Fed there is not enough inflation as their target of 2% has not been met but that they anticipate inflationary pressures as the economy continues to grow as they expect.
The minutes also noted that the Fed is aware of the tightening yield curve – the gap between long term and short term interest rates. That gap has been narrowing recently and many market observers point to history that such a narrowing is a harbinger of a recession.
The Fed’s Balancing Act
The Fed minutes clearly state their dilemma -raise interest rates too much and they choke off the rally, don’t raise them enough and they risk higher inflation and create imbalances in the economy and choke off the rally. In the past the Fed has often acted too aggressively in raising interest rates causing recessions and the subsequent need to rapidly and aggressively cut interest rates in an attempt to mitigate those recessions. Commentators are split on what the Fed might do this time.
This article by BGASC is not, and should not be regarded as, investment advice or as a recommendation regarding any particular course of action.