FOMC Minutes: Here's What Market Expects From US Federal Reserve

The minutes of the meeting of November policy will be announced later on Tuesday by the US Federal Reserve. Markets are usually expecting opinions from FOMC members which could signal the peak in higher interest rates. Also, signs for rate cuts trajectory will be keenly watched especially after recent soft economic data and lower inflation rates. Earlier this month, the Fed kept key rates at a 22-year high.

On November 1st, FOMC said the committee decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 per cent. Through its rates decision, the US Fed seeks to achieve maximum employment and inflation at the rate of 2 per cent over the longer run.

During the policy announcement, FOMC had highlighted that recent indicators suggest that economic activity expanded at a strong pace in the third quarter, while job gains have moderated since earlier in the year but remain strong, and the unemployment rate has remained low.

Also, the committee led by Fed's chair Jerome Powell added that the US banking system is sound and resilient. The committee believes tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation.

However, the extent of these effects remains uncertain, it added. FOMC remains highly attentive to inflation risks.

In October month, US inflation eased to 3.2%, almost in line with market consensus of 3.3%. While the country's GDP growth came in at an annualized rate of 4.9% in the third quarter, which would be the fastest growth in nearly two years.

Broadly, markets are hoping for a positive signal from FOMC minutes.

According to Kotak Institutional Equities report, the market is once again hoping for a 'peak' in US policy rates and a 'pivot' over the next few months after being bludgeoned by the US Fed into accepting the message of 'higher-for-longer' interest rates. The recent soft economic data and lower inflation have revived hopes of rate cuts again, but the likely soft economic activity may temper earnings and growth expectations too.

The brokerage pointed out that bond markets have once again started to pre-empt a 'pivot' by the US Fed over the next few months with (1) inflation data staying at 'low' levels (below 4%) and (2) economic indicators starting to show slowdown in economic activity (especially new net
employment and vacancies data) recently.

It added, "The market now expects the US Fed to hold policy rates at current high levels through 1QCY24 and cut rates gradually after that. The moderation in bond yields in the past 2-3 weeks presumably factors in a more dovish stance of the DM central banks after a spike in bond yields in September-October when the market had got spooked
by the US Fed's hawkish commentary and the US's high fiscal deficit and related borrowing."

However, Kotak believes it is likely that the US Fed will keep policy rates at high levels (5.5% peak policy rate) until it sees low inflation and weak job data for a sustained period of time. In fact, it may choose to err on the side of caution even if economic indicators were to suggest a sharp slowdown in economic activity over the next few months.

Explaining further in detail, Kotak said, the market has taken a long time to accept the 'higher-for-longer' interest rate thesis despite constant and consistent communication from DM central banks on their tight monetary policy stance. In hindsight, the market had been too hasty in (1) assuming a low 'peak' of interest rates and (2) expecting a quick 'pivot' from central banks on interest rates from 'peak' interest levels.

In the next few months, the brokerage expects the economic slowdown in the US to accelerate with (1) lower household savings following reduction in excess household savings accumulated during the pandemic helped by large government handouts and (2) fewer housing starts and related unemployment in a large sector hitting household consumption.

Nevertheless, Kotak does not believe that the slowdown in the US will transform into a recession as the impact of higher interest rates well be felt only in certain parts of the economy (automobile loans, high-yield bonds) with the crucial housing mortgage market largely shielded from the deleterious impact of higher interest rates.

Also, Kotak's note said, "the US Fed can cut interest rates if the US economy was indeed to show signs of a rapid slowdown with attendant job losses and weaker wage increase expectations. We note that Eurozone is already in the middle of a sharp economic downturn."