Divided Fed Was Divided, September FOMC Minutes Show

Fed officials debated when to call an end to the current round of policy easing at their September meeting, as dissension within the committee underscored disagreements about the relative merits of additional “insurance” cuts. There seems to be some discomfort with how the market is pricing the rate path and how some officials see things evolving.

Last month’s pow wow produced a trio of dissents, as Eric Rosengren and Esther George stuck to their guns from July, arguing against a rate cut, while Jim Bullard protested in favor of a larger move.

Officials generally cited slower business investment, trade worries and subdued inflation in the course of justifying the second cut in as many meetings. Here are some relevant passages in that regard:

Participants favoring a modest adjustment to the stance of monetary policy at this juncture cited other risks to the economic outlook that further underscored the case for such a move. As their discussion of risks had highlighted, downside risks had become more pronounced since July: Trade uncertainty had increased, prospects for global growth had become more fragile, and various intermeeting developments had intensified geopolitical risks. Against this background, risk-management considerations implied that it would be prudent for the Committee to adopt a somewhat more accommodative stance of policy. Many participants also cited the level of inflation or inflation expectations as justifying a reduction of 25 basis points in the federal funds rate at this meeting. Inflation had generally fallen short of the Committee’s objective.

As far as the hawkish dissents go, the perception was that the “baseline projection for the economy had changed very little since the Committee’s previous meeting and that the state of the economy and the economic outlook did not justify a shift away from the current policy stance, which they felt was already adequately accommodative”. That may have changed in light of recent data including and especially the ISM surveys.

Markets were interested in any color around how Fed officials viewed the acute funding squeeze that showed up on September 16 and 17. Powell came across as insufficiently concerned in the post-meeting press conference. Ultimately, the New York Fed wrested back control by scheduling overnight repos and conducting a series of term ops, but the message was clear: A permanent solution is needed. The minutes cite the series of widely-discussed factors that contributed to the squeeze. To wit:

However, money markets became highly volatile just before the September meeting, apparently spurred partly by large corporate tax payments and Treasury settlements, and remained so through the time of the meeting. In an environment of greater perceived uncertainty about potential outflows related to the corporate tax payment date, typical lenders in money markets were less willing to accommodate increased dealer demand for funding. Moreover, some banks maintained reserve levels significantly above those reported in the Senior Financial Officer Survey about their lowest comfortable level of reserves rather than lend in repo markets. Money market mutual funds reportedly also held back some liquidity in order to cushion against potential outflows.

The bit about banks clinging to reserve levels above those reported in the Senior Financial Officer Survey underscores the futility of trying to measure reserve adequacy.

“Attempts to measure where reserve scarcity kicks in were always doomed to fail, though hindsight is always 20/20″, BMO”s Jon Hill wrote in a note following the release of the minutes.

On Tuesday, at a speech in Denver, Powell effectively pre-announced “QE-Lite” or, “organic balance sheet growth”, if you like. He was adamant that any buying of T-bills (and that was really one of the more notable takeaways, as it revealed a bit about the operational details behind the upcoming purchases and also indicated that policymakers viewed last month’s dramatics as a direct consequence of the ballooning US budget deficit) does not equate to a relaunch of QE “proper”.

That appeal to rationality (i.e., that investors shouldn’t reengage with “classic” QE trades based on the resumption of balance sheet growth) will likely fall on deaf ears, at least for some market participants, given that the Fed will need to purchase some $300 billion in securities in the first year just to get things back in the “safe” zone of abundant reserves with a “buffer”. That’s a lot of buying, especially considered in the context of the ECB’s recent restart of net asset purchases.

Read more: It’s Not QE, Ok?! Powell Pre-Announces QE-Lite, Hopes You’re Smart Enough To Understand It

The fate of the long-rumored standing repo facility is still up in the air.

Although the minutes are obviously stale in light of subsequent developments and Powell’s remarks in Colorado, traders were still interested to hear what officials were saying as the repo drama unfolded.

The dots are now ambiguous, and recent commentary by Fed officials hasn’t done much to clear things up, although the incoming data (e.g., horrible ISMs and the sluggish AHE print that accompanied September payrolls) suggests there’s room to justify a third consecutive rate cut, especially if trade tensions persist.

“Market participants remained attentive to a range of global risk factors that could affect the policy rate path, including trade tensions between the United States and China, developments in Europe, political tensions in Hong Kong, uncertainties related to Brexit, and escalating geopolitical tension in the Middle East following attacks on Saudi oil facilities”, the minutes read.

Officials cited the trade tensions and the global growth scare as the proximate cause(s) of the market turmoil that unfolded between the July and September policy meetings. “Financial market developments over the intermeeting period were driven by an escalation in international trade tensions, growing concerns about the global economic growth outlook, and the prospect of more policy accommodation by central banks”, the account of the meeting reads.

The minutes are littered with references to trade.

The recap of the events that followed the July rate cut is amusing. “Nominal Treasury yields posted very large declines in August as investors reacted to the U.S. Administration’s announcement of additional tariffs on Chinese goods, along with the depreciation of the Chinese renminbi through the perceived threshold of 7 renminbi per U.S. dollar and the associated implications of these actions for the global economic outlook”, the minutes note.

Of course, all of that was a direct consequence of Donald Trump’s perception that Powell was not convincing in his remarks following the July meeting.

The Fed also references the circularity inherent in policy being effectively dictated by market pricing. “Participants generally viewed the baseline economic outlook as positive and indicated that their views of the most likely outcomes for economic activity and inflation had changed little since the July meeting [but], for most participants, that economic outlook was premised on a somewhat more accommodative path for policy than in July”, the minutes say. That is indicative of a potentially dangerous echo chamber when rate cuts become a self-fulfilling prophecy by virtue of the perceived tightening of financial conditions that would play out were the Fed to disappoint markets.

As far as the contrast between the strong consumer and lackluster investment, “several” participants fretted that “uncertainties in the business outlook and sustained weak investment could eventually lead to slower hiring, which, in turn, could damp the growth of income and consumption”.

Oh, and as for Bullard (and “someone” else), the rationale for a 50bp cut was predicated on “help[ing] reduce the risk of an economic downturn and recogniz[ing] important recent developments, such as slowing job gains, weakening investment, and continued low values of market-based measures of inflation compensation”.

On top of those concerns, the doves “stressed the need for a policy stance– possibly one using enhanced forward guidance–that was sufficiently accommodative to make it unlikely that the United States would experience a protracted period of the kind seen abroad in which the economy became mired in a combination of undesirably low inflation, weak economic activity, and near-zero policy rates”.

In other words, the doves are worried about Japanification.

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