As previewed, the focus on the just released Fed minutes was on two things: the path of the rate hike, which the Fed said it can change its assessment if warranted, and on the future of the Fed's balance sheet, where the FOMC said said a reinvestment shift was warranted, suggesting that a balance sheet reduction would likely begin later this year.
- MOST FED OFFICIALS SAW REINVESTMENT SHIFT WARRANTED LATER IN YR
- FED: BOTH TREASURIES, MBS SHOULD BE PART OF REINVESTMENT CHANGE
- FED OFFICIALS READY TO CHANGE RATE-PATH ASSESSMENT IF WARRANTED
- FOMC TO CONTINUE DISCUSSING REINVESTMENT SHIFT AT UPCOMING MTGS
- FOMC OFFICIALS DIVIDED OVER LEVEL OF SLACK IN LABOR MARKET
* "Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the Committee’s reinvestment policy would likely be appropriate later this year."
* "Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner. Some participants expressed the view that it might be appropriate for the Committee to restart reinvestments if the economy encountered significant adverse shocks that required a reduction in the target range for the federal funds rate."
* "An approach that ended reinvestments all at once, however, was generally viewed as easier to communicate while allowing for somewhat swifter normalization of the size of the balance sheet.
# To promote rapid normalization of the size and composition of the balance sheet, one participant preferred to set a minimum pace for reductions in MBS holdings and, if and when necessary, to sell MBS to maintain such a pace.:"
To be sure, this is hardly the news the bond complex wanted, which has sold off following this latest warning that the Fed may begin shrinking its balance sheet.
However the biggest surprise was in the latest caution by "some" Fed members that stock prices are quite high, and that the Fed is increasingly worried about asset bubbles, to wit:
# SOME FED OFFICIALS VIEWED STOCK PRICES AS `QUITE HIGH'
Here is the section in question: In their discussion of recent developments in financial markets, participants noted that financial conditions remained accommodative despite the rise in longer-term interest rates in recent months and continued to support the expansion of economic activity. Many participants discussed the implications of the rise in equity prices over the past few months, with several of them citing it as contributing to an easing of financial conditions. A few participants attributed the recent equity price appreciation to expectations for corporate tax cuts or to increased risk tolerance among investors rather than to expectations of stronger economic growth. Some participants viewed equity prices as quite high relative to standard valuation measures.
# And this:
"Stock prices rose across most industries, and equity prices for financial firms outperformed broader indexes. Meanwhile, spreads of yields on bonds issued by nonfinancial corporations over those on comparable-maturity Treasury securities were little changed."
And then the punchline, which confirms that the Fed is only focused on the S&P: The Fed explicitly warns of "downside risks" to its forecasts if "financial markets were to experience a significant correction."
*) The passage in question:
A number of participants remarked that recent and prospective changes in financial conditions posed upside risks to their economic projections, to the extent that financial developments provided greater stimulus to spending than currently anticipated, as well as downside risks to their economic projections if, for example, financial markets were to experience a significant correction. Participants also mentioned potential developments abroad that could have adverse implications for the U.S. economy....