Technocrats And Their Deliberations

Why did a handful of technocrats raise their projection for where the panel on which they sit will set the price of money two years from now from near zero to a level that’s slightly higher than, but still very close to, zero?

Read that again. If it sounds like an esoteric debate that virtually nobody should care about, that’s because it is. But the key word there is “should.”

The Fed’s dot plot is, by Jerome Powell’s own admission, mostly useless. Of course, he doesn’t use the term “useless.” Rather, he habitually warns against the media’s penchant for “misinterpreting” it. The scare quotes are there to suggest that mischaracterizations may be purposeful. After all, there’s virtually no way to make the dots amenable to compelling headlines if you characterize them accurately. Imagine seeing this above the fold: “Rates could be slightly higher in 2023, some officials suggest, during working lunch.”

You laugh. Because it’s funny. But that headline, were it real, would be far more accurate than almost all of the headlines that accompany SEP Fed meetings.

Of course, the price of money does matter. At every turn, serious investors are compelled to consider it along with the risk-free rate and liquidity when assessing valuations, the relative attractiveness of equities and market conditions. Money has been free, risk-free rates have been zero and liquidity has been (more than) abundant for so long that I doubt it’s possible to revert to a policy conjuncture that’s materially different without everything falling apart.

That’s why shifts in the dot plot end up catalyzing tremors and “tantrums.” As I put it in “Too Far Gone,” we’ve well and truly passed the point of no return when the mere suggestion, as communicated by a diagram, that policymakers might raise the price of money by a half-percentage point two years down the road, is enough to i) prompt a wholesale rethink of the proper way to trade the yield curve, and ii) throw off headlines like (from Bloomberg) “Fed Shocks Stocks With Blow to Dreams of Value Investor Nirvana.”

And so, traders and investors were compelled to parse the minutes from the June FOMC for clues as to officials’ thinking on the trajectory for rates and monthly asset purchases at a time when inflation has overshot materially while the labor market remains well short of pre-pandemic levels of employment.

The shift in the dot plot at last month’s FOMC raised questions about the Fed’s commitment to average inflation targeting. If they can’t stomach a few months of hot CPI prints that everyone, including the Fed’s most ardent critics, agree are hopelessly distorted, then how could they possibly be expected to countenance a sustained overshoot on the price stability side of the mandate? Are they really going to count a handful of wildly anomalous monthly prints towards their “average”?

Those were some of the questions traders want clarity on, along with any useful color on the timing of a taper announcement. The word “inflation” featured 83 times in the June minutes. The staff outlook described the risks around inflation as “roughly balanced.” To wit:

On the upside, bottlenecks, supply disruptions, and historically high rates of resource utilization were seen as potential sources of greater-than-expected inflationary pressures, particularly if there were a significant rise in inflation expectations that altered inflation dynamics. On the downside, if the effects of supply constraints proved to be transitory, as expected, then the inflation record from the past 25 years suggested the possibility that low underlying trend inflation and a flat Phillips curve could cause inflation to revert to relatively low levels despite a strengthening economy.

The “vast majority of participants” revised their projections for US GDP higher for this year versus their March projections. They cited robust consumer demand and higher vaccination rates. Supply disruptions and labor shortages were seen constraining the expansion.

On inflation, the minutes noted that participants viewed the actual rise in prices as “larger than anticipated.” They cited “widespread supply constraints in product and labor markets” and “a larger-than-expected surge in consumer demand as the economy reopened.”

That said, participants “generally expected inflation to ease as the effect of transitory factors dissipated,” even as “several” suggested supply chain limitations and input shortages would likely persist into 2022. Some said there was simply too much uncertainty “to accurately assess how long inflation pressures will be sustained.” Officials cited trimmed mean measures, which paint a much more benign picture.

There was some disagreement around whether MBS should be treated differently during the forthcoming taper. “Several participants saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets,” the minutes said. “Several other participants, however, commented that reducing the pace of Treasury and MBS purchases commensurately was preferable because this approach would be well aligned with the Committee’s previous communications or because purchases of Treasury securities and MBS both provide accommodation through their influence on broader financial conditions.”

So, there’s a point of contention that’ll need to be sorted out before the official taper unveil. There was, of course, the obligatory nod to the necessity of “provid[ing] notice well in advance of an announcement to reduce the pace of purchases.”

As far as “substantial further progress” goes, there was disagreement there too. “In light of the incoming data and the implications for their economic outlooks, a few participants mentioned that they expected the economic conditions set out in the Committee’s forward guidance for the federal funds rate to be met somewhat earlier than they had projected in March,” the minutes read. And yet, “several participants emphasized that uncertainty around the economic outlook was elevated and that it was too early to draw firm conclusions about the paths of the labor market and inflation.”

In one amusing passage, the minutes noted that “communications about the appropriate path of policy would be a focus of market participants in the current environment” leading some participants to “comment that it would be important to emphasize that the Committee’s reaction function or commitment to its monetary policy framework had not changed.”

I’ll just leave it there.

June FOMC minutes