Fed minutes show inflation risk too high, but economy to avoid recession

Federal Reserve officials hinted at the idea of a 'soft landing' for the U.S. economy, minutes of the central bank's July policy meeting indicated, suggesting a recession will likely be avoided but cautioning on the need for near-term rate hikes.

The minutes, taken from the Fed's policy meeting that ended on July 26, reflect both the central bank's official statement, as well as comments from Chairman Jerome Powell to reporters that followed its decision to lift its benchmark lending rate by a quarter of a percentage point to a twenty-two year high of between 5% and 5.25%.

Policymakers also noted that inflation pressures remain "unacceptably high", adding that more data was needed in order to determine if price pressures are firmly on the patch towards the Fed's 2% target following a two-year low reading for headline CPI of 3% in June.

"Since the emergence of stress in the banking sector in mid-March, indicators of spending and real activity had come in stronger than anticipated; as a result, the staff no longer judged that the economy would enter a mild recession toward the end of the year," the minutes indicated.

"However, the staff continued to expect that real GDP growth in 2024 and 2025 would run below their estimate of potential output growth, leading to a small increase in the unemployment rate relative to its current level," the minutes read.

U.S. stocks were modestly lower following the release of the minutes at 2:00 pm Eastern time, with the Dow Jones Industrial Average down 55 points on the session and the S&P 500 falling 14 points alongside a corresponding rise in Treasury bond yields.

Benchmark 10-year note yields were pegged at 3.254%, nearing the highest levels in fifteen years, while 2-year notes changed hands at 4.982%. The dollar index, which tracks the greenback against a basket of six global currencies, was up 0.23% to 103.401.

The CME Group's FedWatch now indicates an 88.5% chance that the Fed will hold rates steady at its next meeting in September, with bets on a quarter point increase in November rising to around 35.4%.

"Participants noted the recent reduction in total and core inflation rates," the minutes indicated. "However, they stressed that inflation remained unacceptably high and that further evidence would be required for them to be confident that inflation was clearly on a path toward the Committee's 2%objective."

Solid retail sales for the month of July, which showed the key control group reading -- which feeds into GDP calculations -- surging 1% from the prior month, have added to hopes that consumers are weathering the Federal Reserve's aggressive rate hikes while continuing to leverage the earnings power of an historically tight labor market.

The spending rush, however, has revived concerns that the Fed may need to lift rates once more between now and the end of the year in order to keep inflation from ticking higher over the autumn months.

Further signs of a recovery in the housing market added to that concern, with July housing starts rising by a faster-than-expected 3.9%, to an annualized rate of 1.452 million units, even as the Mortgage Bankers' Association said 30-year mortgage rates matched a 2001 high of 7.16% last week.

Get investment guidance from trusted portfolio managers without the management fees. Sign up for Action Alerts PLUS now.