Ok, show of hands: who’s excited about the May Fed minutes?
Crowd full of full pockets, we suppose (that’s a Brick reference).
Be that as it may (get it? “may”), it’s possible that they’ll be something worth extracting here. Specifically, traders will parse these for clues as to whether the FOMC is truly prepared to tolerate a meaningful inflation overshoot in light of the “symmetric” language from the May statement.
This comes a week after 10Y yields hit their highest levels since 2011 and real yields bumped up against the taper tantrum peak. One thing worth noting there is that when it comes to rates vol., it’s the curve that matters, not necessarily some “magic” level on 10s. Here’s BNP:
The markets are focused on the 10y UST, which finally closed through 3% on 15 May and is at 3.10% at the time of writing. Despite making headlines, there is a noticeable lack of panic.
As the Fed has begun hiking rates, volatility has been driven more by the level of the curve rather than the level of rates. Our economists expect four more rate hikes this cycle and this is reflected in the forward curve. Therefore, we expect the recent 2s10s steepening to be limited and the flattening trend to resume.
Fingers crossed on that latter bit – or at least to the extent another bout of bear steepening would entail a spike in rates vol. and a possible spillover.
“This week’s FOMC minutes should confirm the constructive outlook and the Fed’s intent of allowing for a modest overshoot of inflation above target,” Barclays wrote, in their week ahead outlook, adding that the FOMC is “looking for the discussion surrounding the inclusion of the word ‘symmetry’ when referring to the inflation target.”
For their part, BofAML suggests that the minutes could add to the risk of further steepening. “A risk to the flattening however comes from the FOMC minutes, which could hint at a desire to engineer a sustained inflation overshoot following the reference to the ‘symmetric’ inflation objective in the May statement, and/or flag concerns over a possible Fed-induced curve inversion,” the bank wrote over the weekend. Here’s a bit more from their econ team:
We expect the minutes from the May 1-2 FOMC meeting to show that the Committee remains optimistic about the economic outlook but also highlight the debate around the risks to the outlook and the path of policy. We will look for discussions around Fed officials’ views on inflation and their tolerance for core inflation to move above the Fed’s 2% inflation target. Recently several Fed officials have stated that they would be comfortable with a modest overshoot of the inflation objective as it would reinforce the “symmetric” nature of the target. That said, other officials may raise concerns that a sustained overshoot could de-anchor inflation expectation and force the Fed to remove accommodations more quickly than currently expected, disrupting the economy. Also, discussions around recent financial conditions will be noteworthy. Recent public remarks have varied with some citing little concern around the flattening of the yield curve while others have noted that the recent moves in the curve is one of the factors in constructing their view on the path of policy. Lastly, we will also look for discussion around how Fed officials are incorporating the risks from trade and geopolitical tensions.
And listen, despite everything noted above, nobody wants to hear your damn “steepening” story, ok?
For what it’s worth, here are a couple of charts that show the weekly flattening/ steepening (bps) in the 2s10s and 5s30s with the week of the February turmoil highlighted (in red) just to underscore the notion that steepening could be the real tail risk here, despite the obsession with flattening.
And without further ado, here are the minutes.
- “Most participants judged that if incoming information broadly confirmed their current economic outlook, it would likely soon be appropriate for the Committee to take another step in removing policy accommodation.”
- “Overall, participants agreed that the current stance of monetary policy remained accommodative, supporting strong labor market conditions and a return to 2 percent inflation on a sustained basis.”
- “A few participants commented that recent news on inflation, against a background of continued prospects for a solid pace of economic growth, supported the view that inflation on a 12-month basis would likely move slightly above the Committee’s 2 percent objective for a time.”
- “It was also noted that a temporary period of inflation modestly above 2 percent would be consistent with the Committee’s symmetric inflation objective and could be helpful in anchoring longer-run inflation expectations at a level consistent with that objective.”
- “In their discussion of the outlook for inflation, a few participants also noted the risk that, if global oil prices remained high or moved higher, U.S. inflation would be boosted by the direct effects and pass- through of higher energy costs.“
- “Participants pointed to a number of factors contributing to the flattening of the yield curve, including the expected gradual rise of the federal funds rate, the downward pressure on term premiums from the Federal Reserve’s still-large balance sheet as well as asset purchase programs by other central banks, and a reduction in investors’ estimates of the longer-run neutral real interest rate.”
- “A few participants noted that such factors could make the slope of the yield curve a less reliable signal of future economic activity.”
- “However, several participants thought that it would be important to continue to monitor the slope of the yield curve, emphasizing the historical regularity that an inverted yield curve has indicated an increased risk of recession.”
- “Participants commented on how the Committee’s communications in its postmeeting statement might need to be revised in coming meetings if the economy evolved broadly as expected.”
- “Some participants noted it might soon be appropriate to revise the forward-guidance language in the statement indicating that the ‘federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run’ or to modify the language stating that ‘the stance of monetary policy remains accommodative.’”
- “With regard to trade policies, a number of participants viewed the range of possible outcomes for economic activity and inflation to be particularly wide, depending on what actions were taken by the United States and how U.S trading partners responded.”
- “Some participants observed that while these policies were being debated and negotiations continued, the uncertainty surrounding trade issues could damp business sentiment and spending.”
- “It was noted that the potential for higher Chinese tariffs on key agricultural products could, in the longer run, hurt U.S. competitiveness.”
- “All members viewed the recent data as indicating that the outlook for the economy had changed little since the previous meeting.”