Thursday, August 21, 2014

Analysis of Minutes of the Federal Open Market Committee; July 2014

Minutes of the Federal Open Market Committee;  July 29-30, 2014

Untitled Beginning of Minutes
1.     New Subcommittee on Communications: Chaired Governor Fischer, Pres Mester, Gov Powell and Pres Williams.
a.      This was the first notice in the Minutes.  Communication is a very important aspect of the role of Chair for Yellen.  She appears determined to maximize the role of communication in bringing about efficiencies in the use of new and legacy monetary policy tools.
b.     Gov Fischer is not known to be a big fan of forward guidance.
Monetary Policy Normalization
2.     ‘Meeting participants continued their discussion of issues associated with the eventual normalization of the stance and conduct of monetary policy, consistent with the Committee's intention to provide additional information to the public later this year, well before most participants anticipate the first steps in reducing policy accommodation to become appropriate.’
a.      Importantly, the interest is to normalize both the ‘stance’ and ‘conduct’, bringing as soon as possible a return to pre-crisis operating standards.  This outline is intended to be provided before year end. 
3.     ‘The staff detailed a possible approach for implementing and communicating monetary policy once the Committee begins to tighten the stance of policy.’
a.      The choices for implementation and communication appear to have been reduced to ‘a’ approach worthy of staff detail.  All else equal, this points toward an earlier advance of formal exit strategy procedures.  
b.     This is not a new approach, but rather evolved from ‘discussion of normalization strategies and policy tools during the previous two meetings.’
4.     ‘Almost all participants agreed that it would be appropriate to retain the federal funds rate as the key policy rate, and they supported continuing to target a range of 25 basis points for this rate at the time of liftoff and for some time thereafter.’  
a.      Widely supported use of Fed Funds as ‘communication tool’ using a 25 basis point range for a not-indefinite period, but rather reverting eventually to normalization of conduct.
5.     ‘However, one participant preferred to use the range for the federal funds rate as a communication tool rather than as a hard target, and another preferred that policy communications during the normalization period focus on the rate of interest on excess reserves (IOER) and the ON RRP rate in addition to the federal funds rate.’
a.      ‘one’ participant seems not to understand that the use of fed funds at lift-off ‘is’ a communication tool and not a hard target.  The ‘another’ points this out by preferring use of IOER and ON RRP not only as ‘mode of conduct’, but also highlighted as communication tool. 
b.     Only two were not completely yet on board for ‘staff’ proposal of process and communication.  Again, this implies a sooner announcement of exit strategy procedures.
6.     ‘In addition, most thought that temporary use of a limited-scale ON RRP facility would help set a firmer floor under money market interest rates during normalization.’
a.      The Fed appears to want to initiate lift-off with strong use of ON RRP, but when sufficient traction is achieved and Fed communication is capable of ‘directing’ market rates they will reduce the role of ON RRP.
7.     ‘Alternatively, some participants suggested the ON RRP rate could be set below the bottom of the federal funds target range, judging that it might be possible to begin the normalization process with minimal or no reliance on an ON RRP facility and increase its role only if necessary. However, many other participants thought that such a strategy might result in insufficient control of money market rates at liftoff, which could cause confusion about the likely path of monetary policy or raise questions about the Committee's ability to implement policy effectively.
a.      There are ‘some’ participants that want very limited role for ON RRP and would prefer to place under ff target range.  ‘Many’ point to a desire to secure market confidence ‘about a likely path of monetary policy’.  ‘Policy-path’ has become a strong FOMC draw.
8.     ‘Participants expressed their desire to include features in the facility's design that would limit the Federal Reserve's role in financial intermediation and mitigate the risk that the facility might magnify strains in short-term funding markets during periods of financial stress.’
a.      The only noted method for ‘limiting’ and ‘mitigating’ was ‘limiting the program's size’.
9.     ‘In general, they agreed that the size of the balance sheet should be reduced gradually and predictably.’
a.      Gradual and predictable reduction in the size of the balance sheet is ‘a policy-path’. 
10.  ‘A few participants noted that the appropriate size of the balance sheet would depend on the Committee's future decisions regarding its framework for monetary policy.’
a.      There are some who would want a larger balance sheet for a longer time-frame or possibly even as a permanent condition.
11.  ‘Most participants continued to anticipate that the Committee would not sell MBS, except perhaps to eliminate residual holdings.’
a.        This is not a large step away from conferring similarly on Treasury holdings.    
12.  ‘Some others noted that, given the uncertainties attending the normalization process and the outlook for the economy and financial markets, it could be helpful to retain the option to sell some assets.’
a.      The willingness to consider the use of the balance sheet as a ‘tactical’ tool to combat financial excesses.  Awesome, I have been waiting since ’09 for this recognition. 
13.  ‘They stressed the importance of communicating a clear plan while at the same time noting the importance of maintaining flexibility so that adjustments to the normalization approach could be made as the situation changed and in light of experience.’
a.      Of course the Fed wants to play from both sides of the street.  They want the benefit in support for economic growth that comes from ‘communicating a clear plan’.  They also want to retain enough options to adjust the timing, pace and avenue for ‘normalization of policy’ in both ‘stance’ and ‘conduct’.  This is one of the biggest challenges the Fed has and they have created a new subcommittee to help in communicating these variables. 
14.  ‘A few participants also suggested that the Committee should solicit additional information from the public regarding the possible effects of an ON RRP facility, but some others pointed out that the Committee would continue to receive such feedback informally in response to its ongoing communications regarding normalization.’ 
a.      Not everyone is completely comfortable that they have enough information to move forward.  However, a majority understands that novel approaches to monetary policy come with uncertainties and inaction can be as or more dangerous than making informed decisions without complete assurance.  
Staff Review of the Economic Situation  
15.  Growth: ‘…(GDP) rebounded in the second quarter following its first-quarter decline, but it expanded at only a modest pace, on balance, over the first half of the year.’
a.      Moderate is ok, but we learn later in minutes (# 33 below) that somewhat elevated concerns still attend weak Q1 performance.
16.  Inflation:  ‘Consumer price inflation rose somewhat in the second quarter, but futures prices for energy and agricultural commodities generally were trending down over the next couple of years and longer-run measures of inflation expectations remained stable.’
a.      Higher inflation today, but suggesting energy and agriculture to help keep lid on next two years and standard message of longer-run expectations.
17.  Labor: ‘Measures of labor market conditions generally continued to improve…’
a.      ‘…nonfarm payroll employment increased strongly in June…’- ‘…largest since the first quarter of 2012’
b.     ‘…unemployment rate declined to 6.1 percent in June…’
c.      ‘...labor force participation rate was unchanged…’
d.     ‘…employment-to-population ratio edged up…’
e.      …rate of long-duration unemployment moved down…’
f.      ‘…share of workers employed part time for economic reasons edged up…’
g.     ‘…Initial claims for unemployment insurance declined further…’
h.     ‘…rate of job openings rose further in May,…’
i.       ‘…rate of hiring was unchanged and remained at a modest level.’
                                                    i.     Of the 9 labor variables mentioned, ‘a’, ‘b’, ‘d’, ‘e’, ‘g’,  and ‘h’ were constructive (67%), ‘c’ and ‘i’ were neutral (22%), and  ‘f’ was weak (11%).
18.  ‘Near-term inflation expectations from the Michigan survey were little changed, on net, in June and early July, while longer-term expectations declined.’
a.      The is one of the few notices in the Minutes that suggest continued excess accommodation may be appropriate for longer than currently communicated.
Staff Review of the Financial Situation
19.  ‘Financial conditions eased somewhat, on balance…’
20.  ‘Market participants characterized the Federal Reserve's monetary policy communications over the intermeeting period as suggesting a slightly more accommodative policy stance than had been expected.
a.      The committee is now willing to make reference to the general stance of communication over the intermeeting period, giving value judgment to that communication with respect to the difference from perceived market consensus views.  In other words, here is where market consensus is and this was our message relative to that consensus view which may have influenced in ‘this direction’. 
b.     A new step in analysis of communication which may serve to create a more unified intermeeting message.
21.  ‘The median dealer continued to see the third quarter of 2015 as the most likely time for the liftoff of the federal funds rate from the effective lower bound, although, relative to the June survey, the distribution of the modal expected time of liftoff became more concentrated around the third quarter of 2015.’
a.      That a survey of expectations would center more closely around a date as that date approached is not surprising or interesting unless there was a ‘collapse’ of expectation toward Q3 lift-off.  In any event, the Fed can work well with a tight distribution of expectations, pushing those in or out along the timeline as needed. 
22.  ‘The decline in yields at the long end of the curve likely also reflected a continuation of a pattern that began last year, which some market participants attributed to a reduction in investors' expectations for longer-run economic growth and declines in term premiums.’
a.      Bingo. Doubtless this is a strong and lasting influence on long rates.  At what point this influence is ‘overpriced’ is not currently clear, but will at some point be a source of untold rewards.
23.  ‘The staff's periodic report on potential risks to financial stability concluded that relatively strong capital positions of U.S. banks, subdued use of maturity transformation and leverage within the broader financial sector, and relatively low levels of leverage for the aggregate nonfinancial sector were important factors supporting overall financial stability. However, the staff report also highlighted that low and declining risk premiums, low levels of market volatility, and a loosening of underwriting standards in a number of markets raised somewhat the risk of an eventual correction in asset valuations. ‘ 
a.      Wonderfully concise synopsis.
Staff Economic Outlook
24.  ‘To reconcile the downward revision to real GDP growth for the first half of year with an unemployment rate that was now closer to the staff's estimate of its longer-run natural rate, the staff lowered its assumed pace of potential output growth this year by more than it marked down GDP growth. As a result, resource slack in this projection was anticipated to be somewhat narrower this year than in the previous forecast and to be taken up slowly over the projection period.’
a.      This is a big statement that provides a message that the staff believes the output gap is smaller than they earlier believed.  As such, the basis for excessive accommodation is to this extent reduced.
25.  ‘The staff's near-term forecast for inflation was revised up a little, as recent data showed somewhat faster-than-anticipated increases that were judged to be only partly transitory. With a little less resource slack in this projection, the medium-term forecast for inflation was also revised up slightly.’ 
a.      Not entirely transitory up-tic in near-term inflation forecast and the output gap reduction brings higher medium-term forecast.
26.  ‘The staff continued to view uncertainty around its projections for real GDP growth, inflation, and the unemployment rate as roughly in line with the average of the past 20 years.’
a.      The 20 year average is likely longer than most staff remain at the Fed and appears a reference that gives only limited information.  Instead, they might regard uncertainty around projections as trending higher or lower over the last 3-6 months. 
Participants’ View on Current Conditions and the Economic Outlook
27.  ‘Although most participants continued to view the risks to the outlook for economic activity and the labor market as nearly balanced, some pointed to possible sources of downside risk, including persistent weakness in the housing sector, a continued slow rise in household income, or spillovers from developments in the Middle East and Ukraine.’   
a.      A majority note nearly balanced while some rightly point to slow income gains.  ‘Headlines’ of the day have also attracted their attention.
28.  ‘Participants noted that inflation had moved somewhat closer to the Committee's 2 percent longer-run objective and generally saw the risks of inflation running persistently below their objective as having diminished somewhat.’
a.      This is the strongest reference to inflation seen in a long time. 
29.  ‘Participants generally agreed that both the recent improvement in labor market conditions and the cumulative progress over the past year had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run.’
a.      Consistent and unexpected improvement in labor market conditions would suggest, all else equal, a sooner ‘lift-off’. 
b.     Participants offered the following assessments of labor market variables:
                                                    i.     ‘pickup in payroll employment gains’
                                                  ii.     ‘noticeable decline in the overall unemployment rate’
                                                iii.     ‘reductions in… long- duration joblessness’
                                                iv.     ‘reductions in… the number of workers with part-time jobs who would prefer full-time employment’
                                                  v.     ‘labor force participation rate was stable’
                                                vi.     ‘transition rate from long-duration unemployment to employment had moved up’
                                              vii.     ‘increased hiring and turnover in the labor market’
                                            viii.     ‘increases in job openings and hiring plans’
                                                ix.     ‘higher quit rates’
                                                  x.     ‘apparent improvements in matching workers and jobs’
1.     There are 9 of 10 positives and 1 neutral above.
30.  ‘Most now judged that the downside risks to inflation had diminished, but a few participants continued to see inflation as likely to persist below the Committee's objective over the medium term.’
a.      A stronger willingness to move forward with removal of excess accommodation is advance by a belief of reduced risk for deflation.
31.  ‘In their discussion of financial stability issues, participants noted evidence of valuation pressures in some particular asset markets, but those pressures did not appear to be widespread and other measures of vulnerability in the financial system were at low to moderate levels.’
a.      Financial stability does not seem to be a strong source of concern at this point.  Participants appeared unwilling to name, as Chair Yellen had done with ‘media’ and ‘biotech’, any ‘particular asset markets’. 
32.  ‘Indeed, some participants viewed the actual and expected progress toward the Committee's goals as sufficient to call for a relatively prompt move toward reducing policy accommodation to avoid overshooting the Committee's unemployment and inflation objectives over the medium term. These participants were increasingly uncomfortable with the Committee's forward guidance. In their view, the guidance suggested a later initial increase in the target federal funds rate as well as lower future levels of the funds rate than they judged likely to be appropriate.’
a.      We shall look very closely for any changes in the language concerning forward guidance for the policy rate in the Statement at upcoming FOMC meetings.  This is not a single participant concern (‘some’).  Hawks want a forward guidance change.
33.  ‘However, most participants indicated that any change in their expectations for the appropriate timing of the first increase in the federal funds rate would depend on further information on the trajectories of economic activity, the labor market, and inflation. In particular, although participants generally saw the drop in real GDP in the first quarter as transitory, some noted that it increased uncertainty about the outlook, and they were looking to additional data on production, spending, and labor market developments to shed light on the underlying pace of economic growth.’
a.      This is a valid argument for postponing an immediate mover toward lesser accommodation.  The nature of the weakness in the first quarter is not yet fully understood.  Continued observation of forthcoming economic data is needed to provide greater assurances of the transitory nature of first quarter weakness. 
Committee Policy Action
34.   ‘In particular, they worried that the degree of labor market slack was difficult to characterize succinctly and that the statement language might prove difficult to adjust as labor market conditions continued to improve.’
a.      These minutes were approved by all participants and they all agreed to leave the statement ‘as labor market conditions continued to improve’ unencumbered by any conditional reference.  This implies they all expect better labor market conditions ahead.
b.     Additionally, participants are concerned with the aspect of communication for changing value parameters of a collection of labor market condition variables.

The balance of the ‘Committee Policy Action’ section and remainder of the Minutes offers little additional interpretative value.