Despite desperate attempts to jawbone March rate-hike-odds higher, because as Master said last night "we don"t want to surprise the markets", Fed Funds Futures imply just a 36% chance (down from a week ago).
That suggests, if The Fed is serious about March, that today"s minutes must be spun towards that narrative. Here are the five key areas that The Wall Street Journal thinks are most critical...
A March Signal
Since the meeting, Fed officials have sounded increasingly comfortable about raising rates, perhaps as soon as the next gathering, on March 14-15. Philadelphia Fed President Patrick Harker said a move in March is possible, and Dallas Fed chief Robert Kaplan said rates should rise “sooner rather than later.” Chairwoman Janet Yellen said last week the Fed would consider raising rates “at our upcoming meetings,” a phrase that left open the possibility of a March move without committing to one. The minutes could offer a better sense about policy makers’ readiness to raise rates next month.
Balance Sheet Blues
What to do about the Fed’s roughly $4.5 trillion portfolio of assets, or balance sheet, has become one of the year’s biggest questions. Some officials have hinted at a willingness to begin shrinking the balance sheet in the near future, but the February meeting statement didn’t address the topic. Speaking before Congress last week, Ms. Yellen said she was unwilling to use the balance sheet as a monetary policy tool, a contrast with some ideas floated by some of her colleagues. The minutes could shed light on the internal debate among officials about the future of the Fed’s portfolio.Fiscal Policy
The meeting statement made no mention of the economic and monetary consequences of the Trump administration other than a nod to improving consumer and business sentiment readings. Minutes from the Fed’s December meeting indicated officials were split over how to incorporate possible fiscal policy changes into their forecasts. The minutes to be released Wednesday could show whether officials have come to some sort of consensus over how to factor possible tax and spending changes into their monetary policy decision-making.Is Inflation for Real?
Inflation, measured by the Fed’s preferred personal-consumption expenditures price index, has been rising, moving up by 1.6% on the year in December. But it is unclear how much of that increase reflects a short-lived bump from the uptick in oil prices and how much of it is due to underlying strength in the economy. The minutes could help us understand how Fed officials are interpreting recent inflation numbers.Lurking Dangers
The economy’s recent strong patch and talk about the Trump administration’s fiscal priorities—such as tax cuts and spending boosts—have bred speculation that the economy could perform better than expected this year. But that doesn’t mean there aren’t threats still abroad. Although the Chinese economy seems more stable than it did this time last year, it still is grappling with a credit boom. And the eurozone could see new waves of volatility as Greece launches another round of debt negotiations. Do Fed officials see any lurking dangers on the international scene? The latest statement didn’t say, but the minutes might.
While we are every nuance will be scoured for insight, we leave readers with the following chart to show just how crucial a decision on the Fed"s balance sheet is becoming - almost $1 trillion matures in the next two years...
As Bloomberg notes, policy-makers have expressed a preference for passive unwinding over outright asset sales, but details remain sparse. Analysts will look to the minutes for clarity regarding whether officials intend to simply cease reinvestment for all asset classes or whether they will try to modulate the liquidation in a more controlled fashion. Additionally, analysts will attempt to decipher how much interest-rate buffer policy makers want to have in place before initiating the passive liquidation.
Taken together, Goldman notes that recent remarks suggest that officials may be starting to fine-tune their views now that the committee has gotten a couple rate hikes under its belt. They may also be getting ahead of potential criticism from the incoming administration, as some of the economic advisers to President-elect Trump appear to favor a smaller Fed balance sheet with a shorter duration.
Officials Addressing Balance Sheet in Public Comments
And as FX strategist (who writes for Bloomberg) Vincent Cignarella, warned "unwinding the Fed"s balance sheet could get messy."
The Federal Reserve should watch what it says about its $4.5t balance sheet. With so much uncertainty in the market about how it will be reduced, a few mistimed words could roil markets faster than you can mouth “taper tantrum.”
The topic is hot. The Fed’s Bullard and Rosengren have recently said the central bank could use the balance sheet to help tighten policy and other bank presidents have also talked about tapering. Ex-Chairman Bernanke just blogged about it, arguing there’s no need to rush.
Hopefully they’re trying to avoid the past. Bernanke surprised the markets in mid-2013 when he said the Fed might cut back on monthly bond and mortgage-backed securities purchases by $10b. The result, traders panicked and pushed the 10-year yield to nearly 3% from below 2% in four months, sparking a crisis in emerging markets.
If they mess it up this time, it could be worse. The Fed may announce a taper while they are increasing rates and in a bearish bond market, which could exacerbate any move because there are fewer buyers to absorb supply. Tapering a balance sheet of this size has never been done.
The Fed will also be tightening for the first time in more than a decade -- raising the Fed Funds rate without draining reserves is repricing the curve, it isn’t tightening. Increasing rates changes the price of money in circulation, tapering reduces it.
The Fed’s Williams said last week the central bank “won’t be disruptive at all” when it starts to let the balance sheet roll off because it will cause rates to go up, which is “desirable.” How much is desirable?
But if markets don’t get the message or a gradual message isn’t gradual enough, traders won’t wait. They will want to get ahead of the curve and that could lead to a surge in yields.
Some analysts predict yields will rise 15 to 20 basis points, but a fixed-income trader I spoke with said that may just be the reaction on the first day.
As traders will tell you, getting into a long position is easier than getting out.
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We hope that this time the Fed invites the opinions of more actual traders in advance of what could be the most momentuous decision in Fed history, instead of just relying on academics and economists, especially since this could be the one event that leads to immense rewards for those bears who managed to survive the past 8 years of activist central banks pushing the stock market higher at all costs.
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