Fed in no mood to take a break on inflation

Investors who are thinking that the Federal Reserve is about to blink in its fight against inflation should start bracing for disappointment after the release of minutes from the central bank’s May policy meeting offered them little support.

Short-maturity bond yields have retreated since early May as markets weigh weakening economic and corporate data, which markets have interpreted as reason enough for the Fed to temper plans to raise interest rates. Atlanta Fed President Raphael Bostic bolstered this thesis Monday when he told reporters that a “a pause” in interest rate increases “might make sense” in September after a pair of them over the summer.

But there was little in Wednesday’s minutes to indicate that Bostic has much company. To the contrary, the minutes showed a committee broadly preoccupied with inflation above and beyond all else. As Bloomberg Intelligence’s natural-language processing model shows, the Fed minutes were roughly as hawkish as they have ever been this cycle. The indicator tends to rise and fall in line with bond yields.

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Conspicuously absent from the release was the word “pause” or any synonym. The closest thing to it was the suggestion — which the market has heard before — that policy makers would assess the path forward once it gets interest rates to what it considers a more neutral setting, which neither stimulates nor curbs economic activity:

Many participants judged that expediting the removal of policy accommodation would leave the Committee well positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments.

This is the old line about being “data dependent.” One can quibble about the wisdom of data dependency in an environment like this one — knowing that data lags behind and that the Fed is already months late in tackling inflation — but it’s worth taking the committee at its word. If policy makers are following the data, then it’s hard to imagine that they will love what they see from inflation by September.

There’s little doubt that the US economy is facing headwinds, and that’s the point when the central bank is raising rates to bring demand into line with supply. Overly optimistic corporate earnings outlooks probably need to be revised downward. But the worst inflation in 40 years is the committee’s main preoccupation. It isn’t coming to the market’s rescue this soon, and it will be relieved — not appalled — at any sign that consumer demand is moderating for goods and services.

As Fed Chair Jerome Powell said in an interview with the Wall Street Journal’s Nick Timiraos last week, policy makers need to see “clear and convincing evidence that inflation pressures are abating and inflation is coming down.” He also told Timiraos that he’s mainly concerned with the big picture and essentially warned investors not to get too far in the weeds searching for excuses to get bullish again:

Everyone reads the inflation reports very carefully and looks for details that look positive and that kind of thing. But truthfully this is not a time for tremendously nuanced readings of inflation. We need to see inflation coming down in a convincing way. That’s what we need to see. And until we see that, we’re going to keep going. We’re not going to assume that we’ve made it until we see that.

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Powell is focusing on the main numbers, and those figures show that inflation isn’t falling to the Fed’s 2% average target in a “clear and convincing” way. In fact, it has barely come down at all, according to the Cleveland Fed’s daily inflation nowcast through Wednesday. That can be attributed in part to gasoline prices, but maybe it’s best not to get so granular.

Markets and the Fed missed the forest for the trees last year when they dismissed inflation as “transitory.” Focusing on idiosyncratic factors such as used-car prices contributed to policy makers underestimating the problem. Now, even if you believe that the worst is in the past, policy makers won’t be satisfied with inflation going from terrible to just plain bad, nor should they. If it’s allowed to fester there, inflation will reenter the public’s mindset and the country will face increased risks of future spikes.

The same goes for the subtle signs of wavering growth. Investors shouldn’t get caught up in every twist and turn; the Fed isn’t going to change course just because a couple of retailers cut their outlooks. In the big picture, the job market remains historically tight, consumption remains too strong, and a few stock market selloffs won’t deter the Fed from raising interest rates until inflation has been tamed. That’s likely much further off than most investors appreciate.