While the dollar and TSY yields both dropped to session lows shortly after the FOMC announcement hit as traders focused on the Fed disclosure that FOMC voters thought it prudent to await evidence an "economic slowdown is transitory" suggesting the committee still wanted to hike rates but was willing to wait for the certainty of data, Goldman's disagreed and according to a just released assessment by Goldman's Jan Hatzius, the statement was more hawkish than perceived by the market.
Specifically, Hatzius claims that the May FOMC minutes mirrored the statement in "downplaying the weak Q1 GDP print and the soft March inflation data, and also noted that most participants judged that “it would soon be appropriate” for the FOMC to hike again."
Hatzius also pointed out what he highlighted earlier, namely that the minutes contained new information about the eventual process for phasing out reinvestment, which will likely occur by “preannouncing a schedule of gradually increasing caps to limit the amounts of securities that could run off in any given month.”
As a result, Goldman continues to see "an 80% probability of a rate hike at the June meeting and expect this to be followed by another rate hike in September and the announcement of balance sheet normalization at the December meeting. However, we see the risks to the timing of the balance sheet announcement as skewed toward the September meeting."
Here are the key points from his note:
- The minutes to the May FOMC meeting mirrored the statement in downplaying the weak Q1 GDP print as “likely to be transitory,” and also noted that “most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation.” Although the minutes noted that FOMC members judged it “prudent to await additional evidence indicating that the recent slowing” in growth is transitory, we view this as a fairly low bar that the data thus far have met.
- Notably, “several participants” pointed to conditions that could justify a “somewhat more rapid” removal of policy accommodation, such as a faster-than-expected decline in the unemployment rate, a faster increase in wage growth, or highly stimulative fiscal policy changes. This comment might be a bit dated in light of the deterioration of the prospects for fiscal stimulus in recent weeks. On the other side, “a couple” noted that a more gradual pace of tightening might be warranted, especially if inflation proved not very sensitive to a lower unemployment rate.
- On inflation, the minutes noted that “most participants” viewed the soft March data as primarily reflecting “transitory factors” and specifically downplayed “idiosyncratic factors such as a large drop in the measure of quality-adjusted prices for wireless telephone services.” Participants generally thought that inflation would stabilize around 2 percent, though a few “expressed uncertainty about the reasons for the recent unexpected weakness” and its implications for the inflation outlook. On the other hand, “a couple” expressed concern that undershooting full employment “could pose an appreciable upside risk to inflation.” Overall, the minutes implied that participants generally saw the inflation outlook as “little changed,” though we note that these comments are somewhat dated at this point following a second soft CPI report for April.
- The minutes provided new information about the process for phasing out reinvestment, noting that “nearly all” participants supported a staff proposal of “preannouncing a schedule of gradually increasing caps to limit the amounts of securities that could run off in any given month.” The minutes did not clarify how long the phase-in would take or how large the final peak cap would be. While this proposal differs from our prior expectation of a percentage phase-out, the difference appears to be more stylistic than substantive. We interpret the proposal for dollar amount caps as a prudent response to reduce variability associated with MBS prepayment and the irregular monthly schedule of maturing assets. The minutes noted that with a preannounced schedule, the phase-out process “could likely proceed without a need for the Committee to make adjustments as long as there was no material deterioration in the economic outlook,” implying a fairly strong bias toward sticking to the schedule once announced.
- We continue to see an 80% probability of a rate hike at the June meeting. We also continue to expect another rate hike in September, followed by the announcement of balance sheet normalization at the December meeting. However, we see the risks to the timing of the balance sheet announcement as skewed toward the September meeting, in which case the third rate hike of the year would likely be deferred.