FOMC Minutes Signal Balance Sheet Normalization Begins In September, Most Saw Inflation Pick Up

Since the July 26th 'nothingburger' FOMC statement, Nasdaq is down but bonds and bullion are higher as domestic politics and global war have trumped monetary machinations. All eyes in today's Minutes will be on any mention of inflation and the balance sheet. The Fed sees inflation "picking up over the next couple years" but this came before last week's dismal CPI/PPI data (and they noted "downside risks"), and confirmed that they will make a balance sheet move "at upcoming meeting."

Additional headlines:

  • *MOST FED OFFICIALS SAW INFLATION PICK-UP OVER NEXT COUPLE YEARS
  • *MOST FED OFFICIALS BACKED B/SHEET MOVE AT `AN UPCOMING MEETING'

However, The Fed is worried about inflation:

  • MANY FED OFFICIALS SAW WEAK INFLATION DUE IDIOSYNCRATIC FACTORS
  • SOME OFFICIALS CONCERNED BY WEAK INFLATION, ARGUE FOR PATIENCE

The key segments, courtesy of Bloomberg:

On the start of balance sheet unwind:

  • "Although several participants were prepared to announce a starting date for the program at the current meeting, most preferred to defer that decision until an upcoming meeting while accumulating additional information on the economic outlook and developments potentially affecting financial markets."

More on timing:

  • "Participants generally agreed that, in light of their current assessment of economic conditions and the outlook, it was appropriate to signal that implementation of the program likely would begin relatively soon, absent significant adverse developments in the economy or in financial markets. Many noted that the program was expected to contribute only modestly to the reduction in policy accommodation."

On inflation:

  • "Most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term."
  • "Many participants, however, saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside."
  • "Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors."
  • "Participants agreed that a fall in longer-term inflation expectations would be undesirable, but they differed in their assessments of whether inflation expectations were well anchored."
  • "A few participants cited evidence suggesting that this framework was not particularly useful in forecasting inflation. However, most participants thought that the framework remained valid, notwithstanding the recent absence of a pickup in inflation in the face of a tightening labor market and real GDP growth in excess of their estimates of its potential rate."
  • "Some participants expressed concern about the recent decline in inflation, which had occurred even as resource utilization had tightened, and noted their increased uncertainty about the outlook for inflation."

On a possible overshoot in the labor market:

"A few participants expressed concerns about the possibility of substantially overshooting full employment, with one citing past difficulties in achieving a soft landing."

On rising lending risks:

  • "A couple of participants expressed concern that smaller banks could be assuming significant risks in efforts to expand their CRE lending."

On policy uncertainty:

  • "Several participants noted that uncertainty about the course of federal government policy, including in the areas of fiscal policy, trade, and health care, was tending to weigh down firms’ spending and hiring plans."
  • "It was also observed that the budgets of some state and local governments were under strain, limiting growth in their expenditures. In contrast, the prospects for U.S. exports had been boosted by a brighter international economic outlook."

The now traditional commentary on equity markets and financial conditions.

  • Several participants noted that the further increases in equity prices, together with continued low longer-term interest rates, had led to an easing of financial conditions. However, different assessments were expressed about the implications of this development for the outlook for aggregate demand and, consequently, appropriate monetary policy.
  • According to another view, recent rises in equity prices might be part of a broad-based adjustment of asset prices to changes in longer-term financial conditions, importantly including a lower neutral real interest rate, and, therefore, the recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.

On equity valuations:

  • "Participants also considered equity valuations in their discussion of financial stability. A couple of participants noted that favorable macroeconomic factors provided backing for current equity valuations; in addition, as recent equity price increases did not seem to stem importantly from greater use of leverage by investors, these increases might not pose appreciable risks to financial stability."

And the punchline as regards to stocks, confirming that the Fed may have to hike just to burst the stock bubble:

  • According to one view, the easing of financial conditions meant that the economic effects of the Committee's actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.

Of course, any confusion in these minutes can always be cleaned up next week at Jackson Hole.

* * *

Key conclusions:

  • As expected, September remains in play for balance-sheet announcement, though no specific timetable mentioned
  • Most FOMC participants preferred to announce the start of the balance-sheet runoff at "an upcoming meeting," while "several" were ready to go in July
  • Inflation debate deepens. Most officials expected inflation to pick up next couple years and stabilize around 2%; many saw chances inflation may stay below that level for longer than expected
  • Some Fed officials see scope for rate-hike patience, others caution a delay could lead to inflation overshoot
  • FOMC united against a loosening of financial regulations that would allow for risky practices;
  • The Fed is concerned about policy uncertainty hurting investment
  • FOMC discussed equities, agreed to monitor bank behavior; some concern expressed about small-banks' risk in commercial real-estate lending

*  *  *

Rate hike odds for December are around 42% - unchanged from the FOMC Statement in July...

 

Not what The Fed was hoping for...

 

The dollar is unchanged but bonds are bid...

 

Why is the FOMC considering raising rates again this year? Bloomberg notes one reason is concern about asset prices and the potential from the unwinding of a bubble. This could well have been debated, with, for example, Eric Rosengren of Boston particularly worried about commercial real estate, while Yellen has cited stock prices as being elevated.

 

Of course, that's not how the market sees it...

 

Full FOMC Minutes below: