FOMC Minutes Signal "Patient" Fed And Dovish Sentiment: "Downside Risks Increased"

As a reminder, the FOMC raised the fed funds rate target by 25bps in December, in line with the analyst median forecast.

The central bank also narrowed the trajectory of rate hikes going forward, now envisaging two hikes in 2019, and one in 2020 (previously it had seen three hikes in 2019 and one in 2020). Crucially, the FOMC lowered its estimate of the neutral rate (to 2.8% from 3.0%), and additionally, the central bank softened its guidance on future rate hikes, saying that “some further gradual increases” to rates (versus the previous “further gradual increases”), even as the market continues to expect that the Fed's rate hike cycle is now over and even expects a rate cut in 2020. In terms of risks to the outlook, the Fed continues to see these as “roughly balanced”.

But the market is entirely rejecting The Fed's messaging and today's Minutes may hold some color for just how hawkish or dovish The Fed really is...

And, since The Fed hiked rates in December, stock markets have turmoiled back to unchanged. However, one look at the chart below shows that it was in fact only stocks that were chaotic - the trend higher in bonds and bullion (and lower in the dollar) was relatively smooth...

And at the same time as stocks have yo-yo'd so has the market's expectations for just how dovish The Fed will be this year...

In fact, the last week has seen almost all dovishness priced OUT from 2019.

And so all eyes are on the Minutes to see if the "not dovish enough" sentiment within the statement was watered down from a more (or less) dovish perspective in the actual meetings...

It seems the dovishness was deeper in the meeting:

  • *FED OFFICIALS SAW EXTENT, TIMING OF FUTURE HIKES AS LESS CLEAR

  • *MANY OFFICIALS FELT FED COULD BE PATIENT ON FURTHER RATE HIKES

  • *FED: A FEW OFFICIALS FAVORED NO RATE INCREASE AT DEC. MEETING

  • *FED: SOME OFFICIALS NOTED DOWNSIDE RISKS MAY HAVE INCREASED

In other words, the Minutes revealed that the Fed took a more dovish approach to further rate increases than  the statement indicated.

“Many participants expressed the view that, especially in an environment of muted inflation pressures, the committee could afford to be patient about further policy firming,’’

And some of the key highlights:

On The Fed's market-dependency:

Asset prices were volatile in recent weeks, reportedly reflecting a pullback from risk-taking by investors. In part, the deterioration in risk sentiment appeared to stem importantly from uncertainty about the state of trade negotiations between China and the United States. In addition, investors pointed to concerns about the global growth outlook, the unsettled state of Brexit negotiations, and uncertainties about the political situation in Europe.    

On the specifics of the risks facing the U.S.:

"Participants discussed five distinct downside risks to the outlook, including: a sharper-than-expected decline in global growth; a faster fading of fiscal stimulus; heightened trade tensions; further tightening of financial conditions; and a greater-than-expected negative impact from monetary policy tightening so far.''

On the neutral rate :

"With an increase in the target range at this meeting, the federal funds rate would be at or close to the lower end of the range of estimates of the longer-run neutral interest rate, and participants expressed that recent developments, including the volatility in financial markets and the increased concerns about global growth, made the appropriate extent and timing of future policy. Against this backdrop many participants expressed the view that, especially in an environment of muted inflation pressures, the Committee could afford to be patient about further policy firming."

On cautious stance:

"A number of participants noted that, before making further changes to the stance of policy, it was important for the Committee to assess factors such as how the risks that had become more pronounced in recent months might unfold and to what extent they would affect economic activity, and the effects of past actions to remove policy accommodation, which were likely still working their way through the economy."

On FOMC members urging no rate hike in December:

"A few participants, however, favored no change in the target range at this meeting, judging that the absence of signs of upward inflation pressure afforded the Committee some latitude to wait and see how the data would develop amid the recent rise in financial market volatility and increased uncertainty about the global economic growth outlook."

On the contrast between the economy and markets:

"In assessing the economic outlook, participants noted the contrast between the strength of incoming data on economic activity and the concerns about downside risks evident in financial markets and in reports from business contacts."

On being even more data-dependent:

"With regard to the postmeeting statement, members agreed to modify the phrase ‘the Committee expects that further gradual increases’ to read ‘the Committee judges that some further gradual increases.’ The use of the word ‘judges’ in the revised phrase was intended to better convey the data-dependency of the Committee’s decisions regarding the future stance of policy; the reference to ‘some’ further gradual increases was viewed as helping indicate that, based on current information, the Committee judged that a relatively limited amount of additional tightening likely would be appropriate."

And yet, the "Powell put" is alive and well for a Fed that is increasingly attentive to volatility, or this is the Fed's real "data dependency":

Asset prices were volatile in recent weeks, reportedly reflecting a pullback from risk-taking by investors...  One-month option-implied volatility on the S&P 500 index--the VIX--increased over the period and corporate credit spreads widened, consistent with the selloff in equities... The pace of gross equity issuance through both seasoned and initial offerings moderated, consistent with the weakness and volatility in the stock market.

... financial markets were volatile and conditions had tightened over the intermeeting period, with sizable declines in equity prices and notably wider corporate credit spreads coinciding with a continued flattening of the Treasury yield curve; in part, these changes in financial conditions appeared to reflect greater concerns about the global economic outlook. Participants also reported hearing more frequent concerns about the global economic outlook from business contacts.

In their discussion of financial developments, participants agreed that financial markets had been volatile and financial conditions had tightened over the intermeeting period, as equity prices declined, corporate credit spreads widened, and the Treasury yield curve continued to flatten. Some participants commented that these developments may reflect an increased focus among market participants on tail risks such as a sharp escalation of trade tensions or could be a signal of a significant slowdown in the pace of economic growth in the future

And more on why the Fed is once again a seller of vol:

... contacts in a number of Districts appeared less upbeat than at the time of the November meeting, as concerns about a variety of factors--including trade policy, waning fiscal stimulus, slowing global economic growth, or financial market volatility--were reportedly beginning to weigh on business sentiment

On sliding inflation-expectations, also known as oil prices:

"Several participants remarked that longer-term TIPS-based inflation compensation had declined notably since November, concurrent with both falling oil prices and a deterioration in investor risk sentiment."

And speaking of oil prices, the Fed is as clueless as everyone else what is dragging them lower:

"A couple of participants commented that the recent decline in oil prices could be a sign of a weakening in global demand...A couple of participants noted that the recent oil price decline could also be associated with increasing oil supply"

On the danger of the Effective Fed Funds rate rising above the IOER in the rate corridor:

"The staff noted that during the transition to a long-run operating regime with excess reserves below current levels, the effective federal funds rate (EFFR) could begin to rise a little above the interest on excess reserves (IOER) rate as reserves in the banking system declined gradually to a level that the Committee judges to be most appropriate for efficient and effective implementation of policy."

Speaking of the Fed's Balance Sheet, here is why the Fed will be very leery of shrinking assets (and reserves) too much:

... reducing reserves to a point very close to the level at which the reserve demand curve begins to slope upward could lead to a significant increase in the volatility in short-term interest rates and require frequent sizable open market operations or new ceiling facilities to maintain effective interest rate control. These considerations suggested that it might be appropriate to instead provide a buffer of reserves sufficient to ensure that the Federal Reserve operates consistently on the flat portion of the reserve demand curve so as to promote the efficient and effective implementation of monetary policy.

... yet on the other hand:

 In discussing the long-run level of reserve liabilities, participants noted that it might be useful to explore ways to encourage banks to reduce their demand for reserves and to provide information to banks and the public about the likely long-run level of reserves.

Is Operation Twist about to make a return:

"Several participants noted that a portfolio of holdings weighted toward shorter maturities would provide greater flexibility to lengthen maturity if warranted by an economic downturn, while a couple of others noted that a portfolio with maturities that matched the outstanding Treasury market would have amore neutral effect on the market."

And yet at the same time, some FOMC members discussed shrinking balance sheet even faster:

"With regard to the MBS portfolio, participants noted that the passive runoff of MBS holdings through principal paydowns would continue for many years after the size of the balance sheet had been normalized. Several participants commented on the possibility of reducing agency MBS holdings somewhat more quickly than the passive approach by implementing a program of very gradual MBS sales sometime after the size of the balance sheet had been normalized."

Critically, the Fed says economic data is strong but market "data" is not. So which "data" is the "data-dependent" Fed responding when it pauses rate hikes?  

This new messaging fits with Powell who has already pivoted since the meeting (alongside his pals Yellen and Bernanke) to reassure markets that The Powell Put is struck almost as high as the Yellen Put.

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Full Minutes Below (link)