August FOMC Minutes: Increased Risk Of Disinflation, Economy To Slow In 2010, MBS Decision Would Send Wrong Signal About QE2
Update: magical unicorn, meet Neil Patrick Harris
Futures drop on the minutes which disclose increased economic weakness, which is sufficient for magical unicorns to push ES right back up.
On the economt:
In the economic forecast prepared for the August FOMC meeting, the staff lowered its projection for the increase in real economic activity during the second half of 2010 but continued to anticipate a moderate strengthening of the expansion in 2011... Real GDP growth was noticeably weaker in the second quarter of 2010 than most had anticipated, and monthly data suggested that the pace of recovery remained sluggish going into the third quarter. Private payrolls and consumer spending had risen less than expected.
The staff’s forecasts for headline and core inflation in 2010 were revised up slightly in response to the higher prices of oil and other commodities and the depreciation of the dollar.
Participants viewed the risk of deflation as quite small, but a number judged that the risk of further disinflation had increased somewhat despite the stability of longer-run inflation expectations.
While no member saw an appreciable risk of deflation, some judged that the risk of further near-term disinflation had increased somewhat. More broadly, members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.
On the mortgage roll:
The Manager also noted the staff’s projection that, if mortgage rates were to remain near their levels at the time of the meeting, repayments of principal on the agency MBS held in the SOMA likely would reduce the face value of those holdings by roughly $340 billion from August 2010 through the end of 2011. The level of repayments would be expected to increase further if mortgage rates were to decline from those levels. In
addition, about $55 billion of agency debt held in the SOMA portfolio would mature over the same time frame.
The Committee directs the Desk to maintain the total face value of domestic securities held in the System Open Market Account at approximately $2 trillion by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities.
To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longerterm Treasury securities.¹ The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.
On the now-traditional posturing by Hoenig:
Mr. Hoenig dissented because he thought it was not appropriate to indicate that economic and financial conditions were “likely to warrant exceptionally low levels of the federal funds rate for an extended period” or to reinvest principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. Mr. Hoenig felt that the “extended period” expectation could limit the Committee’s flexibility to begin raising rates modestly in a timely fashion, and he believed that the recovery, which had entered its second year and was expected to continue at a moderate pace, did not require support from additional accommodation in monetary policy. Mr. Hoenig was also concerned that these accommodative policy positions could result in the buildup of future financial imbalances and increase the risks to longer-run macroeconomic and financial stability.
On the now imminent QE2:
A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases. Another member argued that reinvesting repayments of principal from agency debt and MBS, thereby postponing a reduction in the size of the Federal Reserve’s balance sheet, was likely to complicate the eventual exit from the period of exceptionally accommodative monetary policy and could have adverse macroeconomic consequences in future years.
As for how to trade this market, just replace NPH with BPS and you are golden.