FOMC Minutes Show Fed Cooling On Yield Curve Control, Fears 'Financial Stability Risks'

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by Tyler Durden
Wednesday, Aug 19, 2020 - 02:05 PM

Since the July 29th Fed Statement, gold is unchanged, stocks are up significantly and bonds and the dollar lower...

Source: Bloomberg

Interestingly, the market's Fed rate trajectory expectations tightened quite significantly with negative rates now off the table for Dec 2021...

Source: Bloomberg

Although we do note that there is no full hike priced in until 2025!

As we detailed earlier, the July FOMC did not "set the foundation" for future policy tweaks, like enhanced forward guidance or yield curve targeting. Analysts believe this sort of policy detail may only follow the Fed's strategy review, likely due in September. Accordingly, the minutes will be parsed to see if there is any emerging consensus on a number of themes, like enhanced forward guidance, inflation targeting, the Fed's mandate, etc.

If it appears as though there is an emerging consensus, it will likely trigger the Fed into shaping its communications accordingly ahead of the Jackson Hole economic symposium, August 27-28, which comes ahead of mid-September FOMC, the last before the November elections.

So, what was the message from today's narrative-shaping Minutes?

The Minutes confirmed that discussions continue on how the central bank designs additional support this year after cutting interest rates to near zero and expanding sharply its $7 trillion asset portfolio to support an economy reeling from the coronavirus pandemic; and how refining that policy statement could help improve transparency.

At this meeting, they discussed potential changes to the Committee’s Statement on Longer-Run Goals and Monetary Policy Strategy. Participants agreed that, in light of fun-damental changes in the economy over the past dec-ade—including generally lower levels of interest rates and persistent disinflationary pressures in the United States and abroad—and given what has been learned during the monetary policy framework review, refining the statement could be helpful in increasing the trans-parency and accountability of monetary policy. Such re-finements could also facilitate well-informed deci-sionmaking by households and businesses, and, as a re-sult, better position the Committee to meet its maxi-mum-employment and price-stability objectives. Partic-ipants noted that the Statement on Longer-Run Goals and Monetary Policy Strategy serves as the foundation for the Committee’s policy actions and that it would be important to finalize all changes to the statement in the near future

Additionally, Fed officials confirmed that the fate of the economy was linked with the uncertain path of the virus.

"In light of the significant uncertainty and downside risks associated with the course of the pandemic and how long it would take the economy to recover, the staff still judged that a more pessimistic projection was no less plausible than the baseline forecast."

“Members agreed that the ongoing public health crisis would weigh heavily on economic activity, employment, and inflation in the near term and was posing considerable risks to the economic outlook over the medium term.” 

“Participants saw less improvement in the business sector in recent months, and they noted that their district business contacts continued to report extraordinarily high levels of uncertainty and risks.”

Some officials worried about financial stability risks if the pandemic persisted. The Fed acknowledges to some extent the divergence between the benchmarks and small businesses facing cash crunches...

"A number of participants commented on various potential risks to financial stability. Banks and other financial institutions could come under significant stress, particularly if one of the more adverse scenarios regarding the spread of the virus and its effects on economic activity was realized. Nonfinancial corporations had carried high levels of indebtedness into the pandemic, increasing their risk of insolvency. "

“In contrast, smaller firms not well represented in the S&P 500 may be experiencing greater effects on their businesses due to the virus -- a possibility consistent with the underperformance of the broader Russell 2000 index over the intermeeting period.”

On Inflation-Targeting:

"A few participants noted a risk that longer-term inflation expectations might move below levels consistent with the Committee’s symmetric 2 percent objective. Participants also noted that a highly accommodative stance of monetary policy would likely be needed for some time to support aggregate demand and achieve 2 percent inflation over the longer run."

And perhaps most critically, on Yield Curve Control:

"A majority of participants commented on yield caps and targets—approaches that cap or target interest rates along the yield curve—as a monetary policy tool. Of those participants who discussed this option, most judged that yield caps and targets would likely provide only modest benefits in the current environment, as the Committee’s forward guidance regarding the path of the federal funds rate already appeared highly credible and longer-term interest rates were already low. Many of these participants also pointed to potential costs associated with yield caps and targets.

Among these costs, participants noted the possibility of an excessively rapid expansion of the balance sheet and difficulties in the design and communication of the conditions under which such a policy would be terminated, especially in conjunction with forward guidance regarding the policy rate. In light of these concerns, many participants judged that yield caps and targets were not warranted in the current environment but should remain an option that the Committee could reassess in the future if circumstances changed...

[Only] a couple of participants remarked on the value of yield caps and targets as a means of reinforcing forward guidance on asset purchases, thereby providing insurance against adverse movements in market expectations regarding the path of monetary policy, and as a tool that could help limit the amount of asset purchases that the Committee would need to make in pursuing its dual-mandate goals."

Additionally BofA notes that the minutes had no discussion of extending the duration of asset purchases, ie “twist”. This narrative had built considerably via media & Dudley speech leading into the meeting.

Full Minutes below: