Having top-ticked US economic data with its March rate-hike, all eyes are on the May minutes to confirm the total lack of data-dependence now present at The Fed. The main focus of the minutes was on the 'normalization' of the balance sheet (since June hike odds are at 100%), which was confirmed with details of the plan revealed. Economic weakness in Q1 was shrugged off as "transitory" - although with the provision that evidence is needed - and tightening as well as balance sheet rolloff is appropriate "soon", likely signaling that a June rate hike is on despite the recent economic slowdown. Fed also warns of asset valuations.
Key Minutes Headlines:
- *MOST FED OFFICIALS SAW TIGHTENING LIKELY APPROPRIATE `SOON'
- *FED BALANCE-SHEET PLAN WOULD RAISE ROLLOFF CAPS EVERY 3 MONTHS
- *FOMC VOTERS: PRUDENT TO AWAIT EVIDENCE SLOWDOWN IS TRANSITORY
The Minutes had something for everyone, starting with the "dovish cop", and the focus on the triple reiteration of "weakness" in the FOMC minutes, and furthermore the warning that Q1 GDP weakness was not due to seasonality:
The staff judged that the weakness in first-quarter real GDP was probably not attributable to residual seasonality and that it instead reflected transitorily soft consumer expenditures and inventory investment.
Another risk factor: the Fed expected PCE inflation to pick up more the spring "which would be more consistent with ongoing gains in employment." It did not happen...
Importantly, PCE growth was expected to pick up to a stronger pace in the spring, which would be more consistent with ongoing gains in employment, real disposable personal income, and households’ net worth.
The Fed also wanted move evidence the slowdown is transitory:
Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation.
However, we then quickly shift to the "hawkish cop" because ironically, just a few lines lower, the Fes does blame the weather:
It was noted that much of the recent slowing likely reflected transitory factors, such as low consumer spending for energy services induced by an unusually mild winter and a decline in motor vehicle sales from an unsustainably high fourth-quarter pace. Nevertheless, contacts expected that demand for motor vehicles would be well maintained.
The outlook is also expected to improve:
With respect to the economic outlook and its implications for monetary policy, members agreed that the slowing in growth during the first quarter was likely to be transitory and continued to expect that, with gradual adjustments in the stance of monetary policy, economic activity would expand at a moderate pace, labor market conditions would strengthen somewhat further, and inflation would stabilize around 2 percent over the medium term.
Sure, it could also be inducted by the collapse in demand for auto and credit card loans as the Fed itself discovered just a few days after the May FOMC meeting in its latest Senior Loan Officer Survey, and reported previously here. Yet despite the Fed's growing concern about "weakness", its conclusion was that gradual tightening remains appropriate:
Although the data on aggregate spending and inflation received over the intermeeting period were, on balance, weaker than participants expected, they generally saw the outlook for the economy and inflation as little changed and judged that a continued gradual removal of monetary policy accommodation remained appropriate.
As for employment and inflation...
Consistent with the downside risks to aggregate demand, the staff viewed the risks to its outlook for the unemployment rate as tilted to the upside. The risks to the projection for inflation were judged to be roughly balanced. The downside risks from the possibility that longer-term inflation expectations may have edged down or that the dollar could appreciate substantially were seen as roughly counterbalanced by the upside risk that inflation could increase more than expected in an economy that was projected to continue operating above its longer-run potential.
Also notable is the Fed's explicit warning that "vulnerabilities have increased for asset valuation pressures."
This overall assessment reflected the staff’s judgment that leverage as well as vulnerabilities from maturity and liquidity transformation in the financial sector were low, that leverage in the nonfinancial sector was moderate, and that asset valuation pressures in some markets were notable. Although these assessments were unchanged from January’s assessment, vulnerabilities appeared to have increased for asset valuation pressures, though not by enough to warrant raising the assessment of these vulnerabilities to elevated.
* * *
"In addition, it was noted that real estate values were elevated in some sectors of the CRE market, that a sharp decline in such valuations could pose risks to financial stability, and that potential reforms in the housing finance sector could have implications for such valuations."
So... the prices are too high?
The Fed also touched on deregulation risks:
"With regard to financial stability, several participants emphasized that higher requirements for capital and liquidity in the banking system and other prudential standards had contributed to increased resilience in the financial system since the financial crisis. However, they expressed concerns that a possible easing of regulatory standards could increase risks to financial stability. "
And on the future balance sheet "renormalization" and runoff:
"Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalized.
* * *
If The Fed somehow makes believe that the data "continues to support" normalization, then their credibility just went negative...
Data-dependence? The Fed is still calling for 2 more rate hikes, the market sees just 1.44 hikes...
So what happens when The Fed balance sheet normalization begins?
June rate hike odds were 100% before the Minutes (and 50% chance of anmother hike by December - 39.3% + 9.6%)
Full Minutes Below...