- The first set of Fed Minutes under Chair Warsh were a bit shorter than recent editions but kept a similar format as prior versions.
- While the inflation was being pushed higher due to tariffs and the war, that was not seen as the only pressure. “Several” participants noted that price pressures have become more broad-based, and pointed out (the obvious) that core services ex housing has “declined little and remained high.” There remain a group of officials with fairly benign disinflationary views but they came across as a bit diffident in the Minutes.
- On the other mandate, officials broadly assessed the labor market as “balanced” overall but also “low dynamism” and not a source of inflationary pressures at the moment.
- Front-end rate vol is likely to remain elevated as forward guidance falls out of favor and the market learns the new Fed Chair’s preferred data, economic framework, reaction function, and communication strategy. The possibility of cyclical reacceleration and continued inflationary pressures make the appropriate level of policy uncertain and, in our view, eventually higher.
The outlook seems far more split around relatively small differences in the inflation outlook rather than the reaction function to incoming data and whatever path of inflation we will ultimately realize. “Almost all” participants noted that should inflation “remain elevated” policy tightening would “likely be warranted.” This scenario assumed a stable, rather than retightening, labor market as well so it shows that hot growth and a sub-4.2% urate are not preconditions for tightening. The same “almost all” think that they can hold rates steady or eventually could should inflation “soon begin to return” to 2%. “Return” and “soon” may both be doing a fair bit of working in keeping that statement symmetric and inclusive of so many participants. This is why I, tentatively, think that gradual data-driven shift towards hikes around the turn of the year is the right base case for now. Earlier hikes seem to require either a sharp upside inflationary surprise over the next few months or a shift towards a preemptive credibility-concerns driven hawkish pivot where going earlier means doing less overall.
The median at 3.3% for core PCE in 2026 is either not hiking or hiking once, while the extra 20bps to 3.5% aligns with 2-3x hikes this year. The gap between the median and the 2-3x hike contingent is really quite fine.
While the Fed continues to take comfort from target consistent measures of inflation expectations, in a hawkish nod, they “emphasized the Committee’s role in keeping those [inflation] expectations anchored.” This also tells us relatively little about the policy outlook given the minimal movement in most long-run expectations measures during the extremes of the last inflationary and hiking cycle. Expectations of the distant future embed a reaction function that assumes the Fed will do what is necessary to meet its dual mandate goals, only one of which is away from target at the moment, over time. If long-run expectations have diverged from target consistent levels any central bank would recognize that the time for hawkish action has already passed. Economic actions, such as the ability of firms to pass-through costs and pre-ordering to try and front-run expected future shortages and price increases, are behavioral tells that are not consistent with the old Greenspan-ian definition of price stability as a rate of inflation where it does not “effectively alter business or household decisions.”
AI-related developments merited substantial discussion at the meeting as well. Unsurprisingly, the two handed economists were out in force with such uncertain medium-term prospects. In the near-term it is serving as an upside source of pressure upwards on rates and inflation “due to strong AI-related demand.” AI is also playing a role in easing financial conditions. Even the optimists noted that “those investments would likely increase the growth of productivity and of potential output in the coming years. These participants remarked, however, that considerable uncertainty remained regarding both the timing and magnitude of potential productivity gains, which were expected to lag the ongoing boost of AI adoption on demand.”
