FOMC Minutes Preview: Will They Be Dovish Enough?
Today’s main market event, the FOMC minutes for the December 2018 meeting, are expected to show some signs the FOMC is tilting dovishly, though the Fed’s more accommodating commentary is unlikely to be fully captured in the minutes, given much of the pivot occurred in speeches post the December FOMC meeting. As such the risk is that the minutes are see as “not dovish enough.”
As Deutsche Bank notes, “the minutes will provide more color on the Committee’s thinking around several key issues for market participants—namely, their views about headwinds from slowing global growth, progress on the Fed’s balance sheet strategy, and the debate around the neutral policy rate.” However, as most investors have pointed out, after Powell’s early-year semi U-turn – and as a reminder, Powell is again speaking tomorrow – the minutes will likely be slightly dated.
In any case, traders will be mindful of comments regarding the Fed’s balance sheet run-off policy (currently on autopilot) after Chair Powell and NY Fed President Williams signaled there may be some flexibility if required. Elsewhere, following the November meeting minutes, traders will be attentive to further discussion on moving away from the “further gradual increases” language.
Here are some more observations of what to expect today courtesy of RanSquawk:
MEETING RECAP: The FOMC raised the fed funds rate target by 25bps, 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”.
Markets initially reacted with caution, perhaps as a result of the narrowing of the trajectory of normalisation, which some suggest could be an acknowledgement of slowing growth momentum; additionally, with the Fed in data-dependency mode, it will examine data that is essentially backwardlooking, which some suggest could lead to a slower reaction function if conditions were to deteriorate, potentially opening the door to a policy error. In his press conference, Chair Powell said “cross-currents” have emerged, and the Fed has seen developments that signal softening ahead, though the developments have not fundamentally altered its outlook yet.
Powell reiterated comments from October that policy is not on a pre-set course, and talked about the Fed’s datadependency, and also said that the FOMC sees some moderation of growth in 2019; tightening financial conditions and slower growth led the Fed to mark down inflation projections. Powell suggested that inflation trends can allow the Fed with patience in normalising policy.
On the neutral rate, he suggested we are now at the bottom-end of the estimate of the neutral rate, while stating that there is a high degree of uncertainty about the path of future hikes; Powell stated that policy does not need to be accommodative and it was appropriate to be neutral. He also said the Fed took tightening financial conditions into account. On independence, Powell said political concerns played no role in the FOMC’s deliberations, and nothing would deter the Fed from doing what it thinks it the right approach. On the balance sheet, Powell said that the policy remained to allow run-offs to occur on autopilot. Although Powell talked up the strength of the US economy, he struck a cautious tone; specifically, 2019 will see a slowdown of growth, and there was a high degree of uncertainty on the rate trajectory. And he does not believe policy needs to be accommodative, and said neutral policy was now appropriate, giving traders little reason to jump into risk.
BALANCE SHEET: Fed officials (notably Powell, Williams) have hinted that there is flexibility on its policy to keep balance sheet normalisation on autopilot, which has helped risk assets to firm at the start of 2019. But there remain other unanswered questions on the policy: Morgan Stanley notes that the Fed has not given a clear signal on when the balance sheet reduction will end, or indeed, what the optimal size for the balance sheet is. Moreover, MS believes that investors are concerned that the Fed has remained on a set course, even though the US and global growth outlook has weakened. And while Powell doesn’t believe that balance sheet policy was an important part of the story of the market turbulence that began in the Q4, the reduction of the portfolio has produced cracks in some asset and credit markets, MS says, observing that US high yield credit spreads are around their widest in 30 months while financial conditions are the tightest in nearly 18 months; and it is the latter that the bank sees as the potential trigger the Fed to tweak its approach. This could be signaled in the minutes by suggestions that not all participants agreed that the run-off plan has proceeded smoothly. With that said, the minutes may fail to provide that guidance, given that Powell said that the run-off is expected to continue. Indeed, comments from Fed officials this later in the week (Powell and Clarida on Thursday are the stand-outs) may offer more in that regard.
FORWARD GUIDANCE: The November meeting minutes signaled that it may soon be appropriate for the FOMC to begin pivoting away from the “further gradual increases” language towards that which places more emphasis on incoming data. In the November minutes, the Committee said that it expects that further gradual increases in the target range for the federal funds rate would soon need to change. “They inserted the word ‘some’ to soften the sentence, but the minutes will probably show that there was a desire to remove it in December,” UBS says.
UNCERTAINTIES: UBS sees the minutes as emphasizing the uncertainties facing the Fed: “The FOMC does not know where the neutral fed funds rate is, where the natural rate of unemployment is, or how much and how long fiscal stimulus boosts the economy,” and as a result, “although it agreed unanimously to hike in December, there was likely a debate about whether more hiking would be needed and how to tell when to stop,” UBS argues. The bank posits that while the lag in monetary policy is known, the length of the lag is not known, and as a result, solely relying on the current data might not be the best approach. “The minutes will reflect Chairman Powell’s characterization of the FOMC ‘feeling its way’ in the dark, as the Fed becomes more data dependent.
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