Fed Minutes Repeat Familiar Talking Points

“There has been surprisingly little reaction thus far.”

So said one observer following the release of the November FOMC minutes on Tuesday.

To the extent markets were indifferent, I can venture a guess as to why: It’s Thanksgiving week and we’re talking about FOMC minutes. It’s hardly high drama. We’re not waiting for Maury to tell us if we’re the father.

Fed officials were marginally hawkish at this month’s policy gathering, the minutes suggested. Officials nodded to the necessity of keeping policy sufficiently restrictive for long enough to return inflation to target, and said they’ll need more evidence to determine if inflationary pressures have truly abated.

Somehow, I doubt that constitutes actionable news to traders keen to bet on “insurance cuts” commencing as soon as March. The Fed has to at least pretend that two-way policy risk still exists even as many officials are plainly concerned about over-tightening, particularly as inflation recedes, mechanically raising the real policy rate.

There was only one thing that mattered in the account of this month’s meeting: The language around tighter financial conditions since July. To briefly recapitulate, the Fed’s rationale for skipping the final hike tipped by the September dot plot revolved around the idea that tighter financial conditions engendered by the selloff at the long-end of the Treasury curve could “stand in” for a rate hike.

But a run of soft data, including payrolls and CPI, served to negate a meaningful portion of that FCI tightening. Indeed, as discussed in this week’s macro preview, the term premium is now barely positive. It was 48bps at the highs last month. Market-based measures of financial conditions have likewise retraced a meaningful portion of the tightening seen late in Q3 and into Q4.

The task for anyone (or any machine) parsing the minutes was to determine the extent to which the discussion at the November gathering indicated the Committee would be inclined to hike again if the FCI tightening were to reverse. Here’s what the minutes said about the FCI impulse, the term premium and the policy reaction function:

Participants judged that the current stance of monetary policy was restrictive and was putting downward pressure on economic activity and inflation. In addition, they noted that financial conditions had tightened significantly in recent months… because of a substantial run-up in longer-term Treasury yields, among other factors. Higher Treasury yields contributed to an increase in 30-year mortgage rates to levels not seen in many years and led to higher corporate borrowing rates. Many participants observed that a range of measures suggested that the rise in longer-term yields had been driven primarily or substantially by a rise in the term premiums on Treasury securities. Participants generally viewed factors such as a fiscal outlook that suggested greater future supply of Treasury securities than previously thought and increased uncertainty about the economic and policy outlooks as likely having contributed to the rise in term premiums. Some participants noted that the rise in longer-term yields may also have been driven by expectations for a higher path of the federal funds rate in light of the surprising resilience of the economy or a possible rise in the neutral policy rate. Participants highlighted that longer-term yields could be volatile and that the factors behind the recent increase, as well as their persistence, were uncertain. However, they also noted that, whatever the source of the rise in longer-term yields, persistent changes in financial conditions could have implications for the path of monetary policy and that it would therefore be important to continue to monitor market developments closely.

So, nothing new. If any tightening in financial conditions not attributable to expectations for a higher Fed funds rate were to persist for a prolonged period of time, that could impact monetary policy deliberations. If not, not. Either way, it’s something the Fed intends to monitor.

As noted above, financial conditions have eased materially this month thanks to sharply lower real yields, a weaker dollar and buoyant equities. All else equal, that suggests the recent FCI tightening doesn’t meet Jerome Powell’s “persistent” test as set out in the November press conference.

But all else isn’t equal for the purposes of forecasting the Fed funds trajectory: The data was almost uniformly soft this month. If that continues in December (i.e., in data covering November), the Fed’s done, and the market will continue to speculate on insurance cuts sooner rather than later. If the data heats up, then the conversation shifts.

I’m afraid that’s about all there is to it. There was some commentary on runoff and RRP. Specifically, “a few participants noted that the process of balance sheet runoff could continue for some time, even after” rate cuts commence. “Several participants commented on the recent decline in the use of the ON RRP facility.”

“Even if the Fed doesn’t truly believe there’s a compelling reason to hike further, adding symmetry at terminal is very typical (and understandable),” BMO’s Ian Lyngen remarked on Tuesday afternoon. “Overall, there was nothing in the release that has offered any divergence from the recent Fed messaging.”