The minutes of the January 29-30 FOMC meeting have two major themes: what to do about balance sheet normalization and the appropriateness of addressing increased risks to the economic outlook with patience in regard to further adjustment in short-term interests. Three weeks ago the FOMC was looking at heightened economic uncertainties, markets still smarting from the deep sell-off in equities in late 2018, and perceptions that Fed officials had been forced to walk back some of their expectations for future rate hikes.
The bottom line was that they were forced to step up communications to ensure that markets understood that monetary policy was not on a preset course, either for interest rates or the normalization of the balance sheet, and that the Fed was prepared to adjust and act according to the available information. Much of this was conveyed by Chair Jerome Powell at his post-meeting press briefing. However, the minutes offered a look at a few technical points.
At the meeting, the minutes said after being briefed by Deputy System Open Market Account Manager Lorie Logan, FOMC participants “raised a number of questions about market reports that the Federal Reserve’s balance sheet runoff and associated ‘quantitative tightening’ had been an important factor contributing to the selloff in equity markets in the closing months of last year.”
In discussing the New York Fed’s findings from market surveys, “While respondents assessed that the reduction of securities held in the SOMA would put some modest upward pressure on Treasury yields and agency mortgage-backed securities (MBS) yields over time, they generally placed little weight on balance sheet reduction as a prime factor spurring the deterioration in risk sentiment over that period. However, some other investors reportedly held firmly to the belief that the runoff of the Federal Reserve’s securities holdings was a factor putting significant downward pressure on risky asset prices, and the investment decisions of these investors, particularly in thin market conditions around the year-end, might have had an outsized effect on market prices for a time.” FOMC participants “also discussed the hypothesis that investors may have taken some signal about the future path of the federal funds rate based on perceptions that the Federal Reserve was unwilling to adjust the pace of balance sheet runoff in light of economic and financial developments.”
The Committee seemed to largely conclude that it would be necessary to reiterate past communications regarding its intentions for reducing the balance sheet and affirm that it would be “flexible” should conditions require it. This in turn prompted the FOMC to reissue its “Longer-Run Goals and Policy Strategy”, and its “Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization.” The former had some minor changes to address the passage of time since it was last revised, and the latter strongly indicated that the present “abundant reserves” and administered short-term rates regime would prevail over the pre-crisis “corridor” system, and that balance sheet normalization could and would change if needed.
The “current regime” of plentiful reserves and an administered rate was determined as “effective both in providing control of the policy rate and in ensuring transmission of the policy stance to other rates and broader financial markets.”
While the minutes did not show that the FOMC had decided on the ultimate size and composition of the Fed’s holdings of Treasurys and Agency MBS, it was clear the consensus is leaning toward bringing the reductions to a close in the latter half of 2019. Thought will be given to how to do this with as little market disruption as possible, and keeping in mind that eventually the Fed would prefer to hold only Treasurys. Also, the FOMC will take steps to ensure that communications are early and precise to avoid misinterpretation by markets about the Fed’s plans. The minutes and the meeting statement and its accompanying statements were intended to address market perceptions that while the present program of balance sheet reductions was running on autopilot, it was not being ignored by policymakers.
The minutes said, “Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities. Some thought that continuing to reinvest agency MBS principal payments in excess of $20 billion per month in agency MBS, as under the current balance sheet normalization plan, would simplify communications or provide a helpful backstop against scenarios in which large declines in long-term interest rates caused agency MBS prepayment speeds to increase sharply. However, some others judged that retaining the cap on agency MBS redemptions was unnecessary at this stage in the normalization process. These participants noted considerations in support of this view, including that principal payments were unlikely to reach the $20 billion level after 2019, that the cap could slightly slow the return to a portfolio of primarily Treasury securities, or that the Committee would have the flexibility to adjust the details of its balance sheet normalization plans in light of economic and financial developments.”
Some recent survey information reported from the New York Fed and other evidence suggested that reserves might begin to approach an efficient level later this year. The minutes said, “Almost all participants” agreed with this, although “A substantial majority expected that when asset redemptions ended, the level of reserves would likely be somewhat larger than necessary” and expected some “further very gradual decline in the average level of reserves, reflecting the trend growth of other liability” such as currency in circulation, “could be appropriate”.
In any case, “Participants commented that it would be important over time to develop and communicate plans for reinvesting agency MBS principal payments, and they expected to continue their discussion of balance sheet normalization and related issues at upcoming meetings.” As such, in the context of the broad view that the program could end in the second half of 2019, I would anticipate a full plan by the April 30-May 1 or June 18-19 meeting to allow time for markets to digest its structure and prepare for implementation.
The meeting included no formal update to the Summary of Economic Projections (SEP) from the December materials. The next one will be released at 14:00 ET on Wednesday, March 21. However, the minutes noted, “Several participants commented that they had nudged down their outlooks for growth since the December meeting, citing a softening in consumer or business sentiment, a reduction in the outlook for foreign economic growth, or the tightening in financial conditions that had occurred in recent months.” This downgrade was consistent with the shift to a “patient” stance on further rate hikes.
On the growth side of the dual mandate, strong labor markets and still solid spending were generally considered to be a reasonable forecast for the near term, in spite of some signs of softening confidence that remained elevated overall. The minutes said, “Concerns about the economic outlook were variously attributed to uncertainty or worries about slowing global economic growth, including in Europe and China; trade policy; waning fiscal policy stimulus; and the partial government shutdown. Manufacturing contacts in a number of Districts indicated that such factors were causing them to delay or defer capital expenditures. In addition, a few participants noted that recent declines in oil or gasoline prices had damped plans for capital expenditures in the energy sector. A few participants observed that conditions in the agricultural sector remained difficult, citing large inventories of agricultural commodities, uncertainty about international trade policies, and concerns regarding low prices of commodities and farmland. However, a few participants commented that business optimism had increased among contacts in their Districts, or that they were planning new capital expenditures. “
On the price stability side of the dual mandate, “Participants continued to view inflation near the Committee’s symmetric 2 percent objective as the most likely outcome. Some participants noted that some factors, such as the decline in oil prices, slower growth and softer inflation abroad, or appreciation of the dollar last year, had held down some recent inflation readings and may continue to do so this year. In addition, many participants commented that upward pressures on inflation appeared to be more muted than they appeared to be last year despite strengthening labor market conditions and rising input costs for some industries.”
The minutes said, “At the time of the December meeting, the Committee had noted that it would continue to monitor global economic and financial developments and assess their implications for the economic outlook. Participants observed that since then, the economic outlook had become more uncertain. Financial market volatility had remained elevated over the intermeeting period, and, despite some easing since the December FOMC meeting, overall financial conditions had tightened since September. In addition, the global economy had continued to record slower growth, and consumer and business sentiment had deteriorated. The government policy environment, including trade negotiations and the recent partial federal government shutdown, was also seen as a factor contributing to uncertainty about the economic outlook.”
Some of these sources of uneasiness about the near future have retreated somewhat. The shutdown is over, although taking its place is President Trump’s decision to declare a national emergency to fund building a border wall that will be subject to a long and bitter legal fight. Trade negotiations with China are proceeding and fresh tariffs may be averted. The Brexit may continue to drag on the other major economies as it nears without a clear path forward.
Ultimately, the minutes said, “Participants pointed to a variety of considerations that supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook”. Markets should be wary of interpreting this patience as any sort of promise or pledge as to future monetary policy beyond more than a few months. As various Fed officials have frequently declared, policymakers are data dependent and will act accordingly.
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