FOMC minutes are coming tonight, is the Fed going to "pour cold water" again?

The minutes of the last Federal Reserve meeting in 2023 are destined to become the first focus of the global market in early 2024.

Currently, traders are imagining that the Federal Reserve will cut interest rates up to 7 times in 2024, with a cumulative reduction of 175 basis points, more than twice the forecast of the dot plot. However, most analysts believe that the minutes of the December meeting of the Federal Reserve are likely to pour cold water on investors. The Federal Reserve does not want its efforts to curb inflation to be stifled by a rapid decline in long-term interest rates.

Some analysts believe that the Federal Reserve may use this meeting minutes to convey a signal of "not in a hurry to act", highlighting the cautious and restrained stance of hawkish members before cutting interest rates.

The minutes of the Federal Reserve's December monetary policy meeting are scheduled to be released at 2 p.m. Eastern Time on Wednesday (3 a.m. Beijing Time on Thursday).

Has the market been confused by the dovish turn?

In November of last year, the Federal Reserve decided to keep interest rates unchanged and stated that the decline in borrowing costs exceeded previous expectations, and it was discussing the possibility of cutting interest rates. The dot plot of the Federal Reserve showed that the Federal Reserve would cut interest rates three times this year, with the federal funds rate falling from the current level of 5.25%-5.5% to around 4.6%.

The dovish stance of the Federal Reserve gave the market endless room for imagination, with a sharp drop in US bond yields, a surge in US stocks, and a decline in the US dollar.

On Tuesday, the latest forecast by futures traders of the Federal Reserve funds rate showed that the Federal Reserve will cut interest rates 5-7 times in 2024, with each cut being 25 basis points, and the cumulative reduction reaching 125-175 basis points. However, they slightly lowered their expectations for the first rate cut in March.

However, shortly after the meeting, the "three heads" of the Federal Reserve, including New York Fed President Williams, poured cold water on the rate cut expectations, stating that there is currently no real discussion of rate cuts, and if necessary, the Federal Reserve must be prepared to raise rates again. Subsequently, several high-ranking officials, including Cleveland Fed President Mester, Chicago Fed President Evans, and San Francisco Fed President Daly, joined the "hawkish camp".

Analysts believe that Federal Reserve officials do not want long-term interest rates to decline so strongly and so quickly, as this would encourage borrowing rather than saving, thereby stifling the achievements in combating inflation.

Lauren Henderson, an analyst at Stifel, Nicolaus & Co., said in an interview with the media:

We know that officials expect to cut interest rates at least three times this year. If the Federal Reserve shows more dovish sentiment and is satisfied with the current state of inflation and its decline from peak levels, this could solidify expectations for at least three rate cuts or even more this year.

If Federal Reserve officials indicate that inflation is still high, this could eliminate some of the urgency for rate cuts, and the market may lower its expectations for the number of rate cuts this year.Former Federal Reserve Director and Chairman of research firm Monetary Policy Analytics, Larry Meyer, pointed out that the December Fed decision to stimulate the market has raised expectations for the number of interest rate cuts. The original prediction was for 5 rate cuts starting in the middle of the year, but now the expectation is for rate cuts to begin in March, with at least 7 cuts.

Meyer believes that there is still a possibility of rate cuts starting in the middle of the year, but there is also a risk of earlier and more frequent rate cuts.

Be cautious and restrained

The minutes of the Fed meeting recorded the predictions and discussions of FOMC members on monetary policy. The members' comments at the meeting were influenced by the CPI (released on the first day of the meeting) and the PPI (released before Powell's speech).

The data released at the time showed that the year-on-year growth rate of US CPI in November slowed slightly to 3.1%, and the year-on-year growth rate of PPI in the same month was 0.9%, the lowest level since June of this year.

The steady decline in inflation has fueled optimism within the FOMC, but not all members hold the same view.

Some analysts believe that since the minutes of the meeting will undergo several revisions before the final draft, the editors may focus on describing the key message they want to convey, namely "not in a hurry to act". It is expected that this report will highlight the stance of hawkish members to remain cautious and restrained before rate cuts.

In summary, what the market may expect on Wednesday night is a slightly hawkish minutes of the meeting, which may trigger a "flight to safety" sentiment in the market, benefiting the US dollar and negatively impacting gold.

However, this impact may not last long.

Firstly, people still hold a relatively optimistic view of a soft landing scenario. Secondly, the market remains skeptical of the Fed's predictions. The Fed admitted late that inflation was not temporary, and it may also admit late that it has done enough or even too much.

Finally, as the Fed has always emphasized its reliance on data, the market believes that there is no reason to fear hawkish statements unless the data highlights new inflationary tendencies.