FOMC minutes More details from the Fed but no more clarity

Heading into the release of today’s FOMC minutes, this week’s most important market move was painting a dramatically different outlook between traders and central bankers.

The big drop in the benchmark 10-year Treasury bond yield, from 1.47% at the end of last week to 1.30% this morning, implies that traders are less concerned with the risk of higher inflation and interest rates, almost the polar opposite of what Fed policymakers appeared to be worried about in last month’s meeting, where they raised their expectations for near-term inflation and interest rates.

As is often the case, the minutes from that fateful June meeting showed a more nuanced, balanced perspective than the official statement could capture.  In the years since announcing its symmetric inflation goal and average inflation target (AIT), the central bank has implied that it would be more “outcome focused” (in other words, explicitly waiting for inflation to rise) than “trajectory focused” (effectively, looking at the trends in inflation and other economic data and projecting what they would do in the future)…but today’s minutes show the tension between those two perspectives nonetheless remains.

Highlights from the minutes follow (emphasis mine):

• “Although inflation had risen more than anticipated, the increase was seen as largely reflecting temporary factors, and participants expected inflation to decline toward the Committee’s 2 percent longer-run objective.”
• “Participants generally judged that, as a matter of prudent planning, it was important to be well positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments, including faster-than-anticipated progress toward the Committee’s goals or the emergence of risks that could impede the attainment of the Committee’s goals.”
• “In coming meetings, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin to discuss their plans for adjusting the path and composition of asset purchases. In addition, participants reiterated their intention to provide notice well in advance of an announcement to reduce the pace of purchases.”
• “Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data.”
• “Participants noted that overall financial conditions remained highly accommodative, in part reflecting the stance of monetary policy, which continued to deliver appropriate support to the economy. Several participants highlighted, however, that low interest rates were contributing to elevated house prices and that valuation pressures in housing markets might pose financial stability risks.”

For those not well-versed in deciphering Fedspeak, the central bank is essentially maintaining the high-level view that inflation is transitory and there is not yet any strong pressure to remove stimulus, but below the surface, some FOMC policymakers are starting to question whether the risks of QE and low interest rates may be starting to outweigh the benefits.

Market Reaction

When it comes to the market reaction, traders are weighing both the additional insight into the Fed’s thought process against recent data, which suggests that we may already be past the peak of inflationary fears. Since the minutes we’re released, we’ve seen the US dollar tick lower, US indices and gold catch a bid, the yield on the 2-year treasury bond hold steady near 0.22%, and WTI crude oil recover off its lows to regain the $72.00 handle.

In essence, traders were hoping for a clearer signal from the FOMC minutes, but considering the ongoing internal tensions at the central bank and the recent downshift in price pressures, they’re left more confused than ever. Looking ahead, next week’s CPI and Retail Sales reports will be the key US data releases to watch for those looking for more insight on the Fed’s normalization plans (which is essentially every trader at this point!).

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