If you wanted to, I suppose you could argue that we didn’t “learn” much from the January Fed minutes, but that wouldn’t be very charitable.
At this point, it’s a kind of “what else do you want from them?” scenario. There was no shortage of color on the rationale behind the “patient” approach, there was plenty to suggest that the committee’s view on inflation has turned more dovish, there was a line about “several participants” opining that further rate hikes this year would only be necessary if inflation shows signs of overshooting and of course there was this:
Almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year.
Is any of that “surprising”? Well, no, not exactly. But pretty much everything the market was implicitly asking (read: demanding) the Fed discuss has now been duly noted, acknowledged and otherwise emphasized in the most overt terms imaginable. The January minutes even contained multiple references to the market’s readily apparent perception that the committee might have been clueless in Q4.
If there’s anything to criticize it’s that the relent was too abrupt – that the decision to end balance sheet runoff stems not from a careful consideration of how QT affects the economy and money markets, but rather from a ham-handed approach that basically boils down to “we’ll quit when risk assets notice”.
Or at least that’s how Jefferies is characterizing things. For the bank’s Ward McCarthy and Thomas Simons, the January minutes betray “a very significant lack of understanding” regarding the relationship between the size of the balance sheet, the economy and money markets.
“In case you suffered from the delusion that the Fed is carefully calibrating what the normalized size of the balance sheet should be” the minutes indicate the Fed is employing only the “roughest of approximations”, McCarthy and Simons write, in a note, adding that “it seems that the goal with balance sheet normalization was to reduce the size only until there was a noticeable impact on financial markets.” Long story short, Jefferies doesn’t believe the Fed has provided a “solid” enough rationale.
But as we learned in Q4, if everyone believes something is a problem, it’s a problem. Once market participants zeroed in on runoff and began citing the “auto-pilot” characterization as a reason to dump risk assets, the stage was set for that selling to feed on itself. If that goes on long enough, it has the potential to become self-fulfilling as lengthy drawdowns can start to manifest themselves in real economic outcomes (e.g., reduced consumer spending as the vaunted “wealth effect” goes into reverse, corporate management teams altering their strategies as credit spreads widen, and on and on).
Indeed, the January minutes made it clear that some market participants didn’t care one way or another about the ostensible “facts”. Take this passage for instance:
Following the briefing, participants raised a number of questions about market reports that the Federal Reserve’s balance sheet runoff and associated “quantitative tightening” had been an important factor contributing to the selloff in equity markets in the closing months of last year. While respondents assessed that the reduction of securities held in the SOMA would put some modest upward pressure on Treasury yields and agency mortgage-backed securities (MBS) yields over time, they generally placed little weight on balance sheet reduction as a prime factor spurring the deterioration in risk sentiment over that period. However, some other investors reportedly held firmly to the belief that the runoff of the Federal Reserve’s securities holdings was a factor putting significant downward pressure on risky asset prices, and the investment decisions of these investors, particularly in thin market conditions around the year-end, might have had an outsized effect on market prices for a time. Participants also discussed the hypothesis that investors may have taken some signal about the future path of the federal funds rate based on perceptions that the Federal Reserve was unwilling to adjust the pace of balance sheet runoff in light of economic and financial developments.
In other words: “You don’t understand.” “No, you don’t understand – people are selling, which means the actual mechanics of this no longer matter.”
Recall this visual from Goldman which shows you just how sensitive market participants suddenly became to this issue starting late last year compared to previous communications regarding runoff:
Looking out across desks, Barclays now expects the Fed to announce in March an intention to end runoff in June. To wit, from a note out Wednesday afternoon:
Based on our estimates, the level of excess reserves at the end of June will be in the neighborhood of $1.4trn. We see this as a natural time for the Fed to end its policy of letting maturing securities roll off its balance sheet. Thereafter, beginning in July, any maturing principal from the Fed’s holdings of Treasuries and MBS securities will be re-invested into Treasuries, keeping the size of the SOMA portfolio stable. Our assumptions indicate that we expect the Fed’s holdings of MBS securities will continue to decline over time, as the Fed has repeatedly indicated its preference to return to an all-Treasury portfolio if possible. Given that currency in circulation is growing by roughly $10bn a month, the level of bank reserves will still gradually decline despite stable securities holdings. We expect the level of bank reserves to reach a terminal value of $1.2-1.3trn before year-end. Hence, while we expect securities redemptions to end in June, we do not expect the terminal level of reserves to be reached until Q4, consistent with Fed communication that the “complete normalization of the size of the balance sheet” is likely to be accomplished by year-end.
For their part, Goldman also sees March as likely when it comes to when an announcement will be made.
“Based on the minutes and recent Fed commentary, we now expect an announcement at the March meeting that runoff will stop at the end of Q3 and that reserves will be gradually reduced somewhat longer via the growth of nonreserve liabilities”, the bank’s Jan Hatzius wrote in a brief postmortem.
So while there’s broad consensus on the balance sheet, some see the language around rates (or actually, the lack of nods to cuts) as slightly hawkish (believe it or not).
“The lack of commentary on impending rate cuts is also informative to suggest an upside bias to the rate path through the rest of the year”, BMO’s Jon Hill writes, adding that “the market is interpreting this as marginally hawkish as the possibility of additional hikes remains in place.”
Capital Economics doesn’t necessarily agree. “[The bar for rate hikes] seems to be quite high”, Paul Ashworth said, following the release of the minutes. He now thinks the Fed will be on hold through the end of the year.
In any case, the bottom line is that runoff is going to stop and you can expect an official announcement on that next month. Invariably, some of the same people who spent December insisting that halting balance sheet rundown was imperative to avoid a further crash in equities will now turn right around and criticize the Powell Fed for listening.
A thankless job, indeed.