FOMC Members Highlight Inflation Risks in March

The Federal Reserve Open Market Committee (FOMC) held the federal funds rate at a target range of 3.50% to 3.75% in March.

The minutes showed that the committee is still concerned about inflation remaining above 2%.  Some noted that “progress in reducing inflation had been absent in recent months” and that “the rate of increase in core goods prices remained well above the pace likely to be consistent with the sustainable achievement of the Committee’s inflation objective”. However, the expectation remains that inflation would gradually reach the “2 percent objective after the effect of increased tariffs and higher oil prices had faded.”  A prolonged conflict in the Middle East was cited as an upside risk where higher energy prices could raise input costs and these “would be more likely to pass through to core inflation.” Partly due to the risks to the outlook, “the vast majority or participants” noted that progress to the inflation target “could be slower than previously expected” and that the risk of inflation staying above the target had increased.

With respect to the labor market, participants judged it to be roughly balanced. The rate of job creation was expected to stay in line with slower labor force growth, leaving the unemployment rate relatively unchanged. However, the risks to the labor market were judged to be skewed to the downside, with low net job creation, higher unemployment among prime age workers, and the concentration of job gains in the health-care sector being cited as reasons. “Many participants” also cited “business contacts and surveys suggesting that firms were likely to delay or reduce hiring in anticipation of AI adoption”.

Importantly, “[m]any participants judged that, in time, it would likely become appropriate to lower the target range for the federal funds rate if inflation were to decline,” as expected. However, the minutes noted that, “[s]ome participants judged that there was a strong case for a two-sided description” of future interest rate decisions, to better reflect that “upward adjustments to the target range” might be necessary if inflation were to stay above the target range. The minutes emphasized that policy decisions would be made on a “meeting-by-meeting” basis.

The risks to the outlook remained high and “the vast majority of participants judged that upside risks to inflation and downside risks to employment were elevated” and that they “had increased with developments in the Middle East”.

Key Implications

Unsurprisingly, the risks around the inflation outlook were pronounced in the weeks after the onset of the conflict in the Middle East. The duration of the conflict is a key factor for inflation going forward and the participants reaffirmed that they would be making decisions on a meeting-by-meeting basis.

Despite today’s news of a ceasefire, energy prices remain elevated, while the course of the conflict and any future disruptions remain highly uncertain. The inflation shock has started and will gradually disseminate through the economy. Nonetheless, our baseline view is that as the shock gradually fades, so too will inflation pressures. This may open the door for the Fed to normalize rates in the latter half of the year.