[Comprehensive] Despite Signaling Additional Rate Hikes, "Pace Should Slow"... Fed's Dilemma

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[Asia Economy New York=Special Correspondent Joselgina] The U.S. central bank, the Federal Reserve (Fed), reaffirmed its stance to continue raising interest rates until inflation falls significantly. However, it also left open the possibility of slowing the pace of hikes at some point. This reflects the Fed's dilemma of trying to curb soaring prices while avoiding an economic recession once the neutral interest rate is reached.

According to the minutes of the July Federal Open Market Committee (FOMC) regular meeting released on the 17th (local time), participants agreed that "inflation is well above the target (2%), and adopting a restrictive policy stance is essential for the Committee to fulfill its mandate of maximum employment and price stability." This implies that some economic growth slowdown may be tolerated in the process of raising rates to control inflation.

Participants argued that "a significant risk facing the Committee is that if the market begins to doubt the Fed's commitment to price stability, elevated inflation could become entrenched." This is a warning that failing to curb inflation through proactive, high-intensity tightening at this stage could lead to an irreversible situation.

However, the Fed also indicated that a prolonged period of large rate hikes is unlikely. The minutes stated, "While assessing the cumulative effects of monetary policy adjustments on economic activity and inflation, at some point it will be appropriate to slow the pace of rate increases."

This statement aligns with remarks made earlier by Chairman Jerome Powell during a press conference. Additionally, many participants cautioned that "there is a risk of tightening monetary policy more than necessary." There is concern that focusing solely on inflation and raising rates excessively could lead to an 'overshooting' that triggers a recession.

The current U.S. benchmark interest rate stands at 2.25?2.50%. Since entering the rate hike cycle in March, the Fed has raised the benchmark rate by a total of 2.25 percentage points. Considering that monetary policy takes considerable time to take effect, it is assessed that the Fed's concerns have become more pronounced now that the neutral rate has effectively been reached.

The neutral rate refers to the interest rate at which the economy can achieve its potential growth rate without inflationary or deflationary pressures. In the ongoing tightening cycle, the Fed's dilemma of balancing inflation and growth can only deepen. The minutes also noted that no predetermined path for future rate hikes has been set. The magnitude and pace of rate increases will ultimately be decided based on a comprehensive assessment of economic indicators.

The minutes released on this day are considered less hawkish than initially feared. However, they were also not as dovish as the market had hoped. Christopher Lo, Chief Economist at FHN Financial, conveyed a mixed sentiment, saying, "While the need to curb inflation continues to be emphasized, there are concerns that the Fed might tighten more than necessary." Case Lerner, Co-Chief Investment Officer (CIO) at Truist, commented, "I don't think there is a significant change compared to thoughts before the minutes were released."

Currently, the market largely expects the Fed to opt for a 0.5 percentage point rate hike at the September FOMC meeting instead of a third consecutive giant step (0.75 percentage point increase). According to the Chicago Mercantile Exchange (CME) FedWatch tool, the federal funds (FF) futures market on this day priced in over a 64% chance of a 0.5 percentage point hike in September, slightly up from 58% a week ago and 59% the previous day. Signs of inflation easing, such as in the Consumer Price Index (CPI) following last month's FOMC meeting, have supported this outlook.

Following the release of the minutes, major indices on the New York Stock Exchange reduced their losses but still closed lower due to earlier reports of weak retail sales and earnings concerns. Asian markets, including South Korea and Japan, also showed broad weakness. The KOSPI opened lower on the 18th, falling below the 2500 mark intraday for the first time in five trading days. On the same day, the won-dollar exchange rate opened at 1315.0 won, up 4.7 won from the previous day.