June FOMC Minutes: Still a data-driven reaction function (not a regime shift)

Research evidence excerpt

June FOMC Minutes: Still a data-driven reaction function (not a regime shift)

UpdateMto raise rates if labor markets are stable, energy prices remain firm, tariff effects stay, and

demand side price pressures are firm. In these scenarios, "some policy firming would likely

be warranted." Here, "some" is doing the heavy lifting. We read this as a "recalibration" of

the policy stance (e.g. 50-75bp of hikes) and something short of a hiking cycle.

In our forecast, two of the three drivers of inflation firming begin to abate in 2H 26 (the

energy price shock and tariff pass through to goods prices) and this helps inflation to

come down, keeping the Fed on hold this year. But the need to see this "soon" suggests

the Fed may not have a tremendous amount of patience at this stage; its patience for

"looking" through transitory supply-side price pressures may be near an end. We do not

think the data warrant a hike in July, but it is conceivable that above-expectations prints on

inflation could get the committee moving in September.

The minutes do not point to a "regime shift" in the reaction function

Some clients expecting rate hikes have suggested the incoming data matters less and the

incoming chair desires a "regime change" in the Fed's reaction function. These clients point

to his remarks on five years of above-target inflation as suggesting the Chairman has

largely made up his mind and prefers more restrictive policy rates to return inflation to 2%

more quickly. We have a hard time arguing against this view since it is a statement on the

new Chairman's reaction function, which remains to be seen.

However, we note that the minutes do not point to a "regime shift" in the Fed's reaction

function toward higher policy rates. Our reading of the paragraph on the outlook for