Last night we received the minutes from the FOMC meeting in May which proved to be a little more ‘dovish’ than expected regarding interest rate policy. While most voters still saw tightening as likely to be appropriate 'soon,' other voters felt it was prudent to wait for further evidence that the first quarter slowdown was transitory. The Fed expected consumer spending to rebound in coming months, however, a few members voiced their concerns that the progress towards the Fed’s inflation goal had slowed.
In our read of the minutes there are a couple of phrases to take on-board. The first ‘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', and also '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.’
So with a hike in June priced in at around 92% by the OIS futures market (at time of writing), which we feel is appropriate, for the moment, it does appear that the Fed is leaving the door slightly ajar should there be a continuation of weaker data. However, with the June meeting just 20 days away we would need to see a big drop in class one data such as Non-farm Payrolls on the 2nd of June to sway the Fed from their current path.
The other item the markets are hooked on is the ‘Balance sheet question’ and the timing and speed of the end of reinvestment. It would appear from the minutes that the reduction in the balance sheet could be sooner than previously thought. Utilising terms such as ‘nearly all policymakers’ and ‘it would likely be appropriate to begin reducing the Federal Reserve’s securities holdings this year’ indicates to us that the Fed is virtually in agreement on the approach and an earlier announcement should be expected, but also the ‘taper’ could be a rather longer drawn out project with or without interest rate rises.
Although ‘past performance is no guarantee of future performance’ since 1950 the Fed has moved into a tightening posture on thirteen occasions, ten of these have ended up with a recession and the other three were ‘soft landings’ as they were early in the business cycle, in essence the Fed has never managed to avoid a recession especially not from a business cycle as mature as today's.
So the Fed has a very difficult balancing act to perform, rising rates and withdrawing an accommodative balance sheet at the same time.
Pssst, buy bonds, you can get them here!
Enjoy the rest of your day.