woensdag 5 juli 2017

FOMC Minutes Show "Divided" Fed Fearful Of High Asset Prices, Low Inflation

Having hiked in June amid gravely disappointing macro-economic data, all eyes are now on the minutes for inflation (weakness blamed on "idiosyncratic factors"), labor market (concerns about "sustained employment undershoot"), balance sheet normalization (Fed "divided" over when to start), and market valuation concerns ("equity market high on standard metrics"). Rate hike odds for Sept (22%) and Dec (56%) were rising into the release. Additional headlines...
*FED OFFICIALS DIVIDED OVER WHEN TO START BALANCE-SHEET RUNOFF
*FED OFFICIALS REPEATED SUPPORT FOR GRADUAL INTEREST-RATE HIKES
*A FEW FED OFFICIALS SAW EQUITY PRICES HIGH ON STANDARD METRICS
*FED OFFICIALS NOTED FINANCIAL CONDITIONS EASED DESPITE HIKES
*A FEW OFFICIALS SAW LOW VOLATILITY STOKING RISKS TO STABILITY
*MOST FED OFFICIALS BLAMED SOFT PRICES ON IDIOSYNCRATIC FACTORS
*FED DEBATED PROS, CONS OF SUSTAINED UNEMPLOYMENT UNDERSHOOT
# Some of the key highlights from the minutes, first on the timing of the next rate hike, where the FOMC appears split: "Participants expressed a range of views about the appropriate timing of a change in reinvestment policy. Several preferred to announce a start to the process within a couple of months; in support of this approach, it was noted that the Committee’s communications had helped prepare the public for such a step. However, some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation." "A few of these participants also suggested that a near-term change to reinvestment policy could be misinterpreted as signifying that the Committee had shifted toward a less gradual approach to overall policy normalization."
# On balance sheet normalization: It was observed that the ensuing reduction in securities holdings would be gradual and would follow an extended period of Committee communications on balance sheet normalization policy, including the information that would be released at the conclusion of this meeting. Consequently, the effect on financial market conditions of the eventual announcement of the beginning of the Federal Reserve’s balance sheet normalization was expected to be limited. Several participants indicated that the reduction in policy accommodation arising from the commencement of balance sheet normalization was one basis for believing that, if economic conditions evolved broadly as anticipated, the target range for the federal funds rate would follow a less steep path than it otherwise would. However, some other participants suggested that they did not see the balance sheet normalization program as a factor likely to figure heavily in decisions about the target range for the federal funds rate. A few of these participants judged that the degree of additional policy firming that would result from the balance sheet normalization program was modest.
# On the lack of inflation, which was blamed on "idiosyncratic factors" whatever that means: "Most participants viewed the recent softness in these price data as largely reflecting idiosyncratic factors, including sharp declines in prices of wireless telephone services and prescription drugs, and expected these developments to have little bearing on inflation over the medium run. Several participants expressed concern that progress toward the Committee’s 2 percent longer-run inflation objective might have slowed and that the recent softness in inflation might persist."
# On unemployment and the collapse of the Phillips curve: "A couple of participants expressed concern that a substantial undershooting of the longer-run normal rate of unemployment could pose an appreciable upside risk to inflation or give rise to macroeconomic or financial imbalances that eventually could lead to a significant economic downturn. Several participants expressed concern that a substantial and sustained unemployment undershooting might make the economy more likely to experience financial instability or could lead to a sharp rise in inflation that would require a rapid policy tightening that, in turn, could raise the risk of an economic downturn."
# On the failure of the Fed to tighten financial conditions and high equity prices: "They also noted that, according to some measures, financial conditions had eased even as the Committee reduced policy accommodation and market participants continued to expect further steps to tighten monetary policy." "Corporate earnings growth had been robust; nevertheless, in the assessment of a few participants, equity prices were high when judged against standard valuation measures." Most notably, however, as Bloomberg Intelligence noted, financial stability concerns appear to be very high on policy makers’ radar and seem to be pushing the Fed’s hand to continue to gradually tighten policy. Some participants suggested that increased risk tolerance among investors might be contributing to elevated asset prices more broadly; a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.
# As for the balance sheet, a September kickoff for the program is what traders widely expect. Any delay may affect calculations on the next rate hike (expected in December) and it may signal the Fed is worried about roiling markets, which ironically, may roil markets. "A few of these participants also suggested that a near-term change to reinvestment policy could be misinterpreted as signifying that the Committee had shifted toward a less gradual approach to overall policy normalization. Several preferred to announce a start to the process within a couple of months,” the minutes showed. “Some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation.”
# Finally, on poor C&I Loan growth, traditionally a precursor to recession. Commercial and industrial loans outstanding increased in April and May after being weak in the first quarter, al­though the growth of these loans remained well below the pace seen a year ago. Issuance of both corporate debt and equity was strong. Gross issuance of institutional leveraged loans was solid in April and May, al­though it receded from the near-record levels seen over the previous two months.
*) Since the Fed hiked rates in June, the Treasury curve is flatter, FANG Stocks are down, and gold has been hit hard...


September hike odds have tumbled since June but December has risen to 42%...


Several Fed members noted "somewhat rich" asset valuations. Indeed, during the history of the stock market, it has only traded at a richer valuation during one period, June 1997 to September 2001, as the dotcom farce blew and burst. Historical data for the index is available going back to 1881...


No matter what The Fed said, they have some large maturities to deal with very soon...

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