The bond market reacted to hawkish Fed meeting minutes days in advance: why?


Many words were spilled today in the minutes of the Fed’s supposedly hawkish FOMC meeting. Let’s go through several things that no one else seems to have caught on.

Hiking in March?

The WSJ reports that the Fed minutes point to a possible rate hike in March.

Minutes from their December 14-15 meeting, released on Wednesday, showed officials believed rising inflation and a tight labor market may require a short-term rate hike “sooner or later. a faster pace than the participants had anticipated “.

FOMC meeting report released today

Let’s take a look at the FOMC meeting minutes released today, highlighting mine.

Discussion of policy standardization considerations

The participants’ discussion was preceded by presentations from the staff. Staff reviewed the previous episode of normalization, including how the Committee began normalization by increasing the target range for the federal funds rate, and then reducing the Federal Reserve’s holdings of assets in a gradual and predictable manner, as well as the timetable for these steps.

Participants generally emphasized that, as in the previous normalization episode and as stated in the Committee’s Statement on Long-Term Goals and Monetary Policy Strategy, changes in the target range of the federal funds rate should be the main means at the Committee’s disposal for adjusting the stance of monetary policy. policy in support of its objectives of maximum employment and price stability. This preference reflected the idea that there was less uncertainty about the effects of changes in the federal funds rate on the economy than about the effects of changes in the Federal Reserve’s balance sheet.

[Mish: That last sentence above is amusing given the Fed was hell bent on expanding its balance sheet to the point it was forced to take close to $2 trillion back via reverse repos. Now after padding the balance sheet it is less certain what to do about it.]

A few participants also noted that when the federal funds rate moves away from the effective lower bound (ELB), the Committee may be more able to modify interest rate policy than balance sheet policy in response to economic conditions.

[Mish: Please note the Fed, unlike the ECB, is very concerned that the ELB is above zero. The ECB cut rates well below Zero. The Fed has concerns]

Participants had an initial discussion about when and when to begin the balance sheet runoff in relation to the ELB’s federal funds rate increase. They also discussed how this relative timeline might differ from the previous experience, in which the balance sheet runoff began almost two years after the policy rate took off when normalization of the federal funds rate was deemed well advanced. .

Almost everyone agreed that it would likely be appropriate to begin a balance sheet runoff at some point after the first increase in the target range for the federal funds rate. However, participants felt that the appropriate timing for the balance sheet runoff would likely be closer to the key rate hike than in the Committee’s previous experience.

[Mish: It took the Fed two full years to begin balance sheet reduction after the last rate hike cycle began. The preceding two paragraphs suggest it will be faster this time.]

Some participants noted that removing the political accommodation of relying more on balance sheet reduction and less on policy rate hikes could help limit the flattening of the yield curve during policy normalization. A few of these participants expressed concern that a relatively flat yield curve could negatively impact the interest margins of some financial intermediaries, which could increase financial stability risks.

[Mish: Once again we see Fed worry over yield curve flattening.]

While participants generally continued to anticipate a significant drop in inflation during 2022 as supply constraints ease, almost all said they had revised their inflation forecasts upwards for 2022 in particular, and many have done so for 2023 as well.

The bond market reacted before the minutes – Why?

1: practical leak?

2: Lucky Riddle or Random Events?

3: New economic data?

4: a brilliant business?

I can’t find any proof of # 3 but guess I may have missed something.

Regardless of the answer, it doesn’t make sense in the long run, but if it is a leak, it matters, especially for those affected or leading the trade.

Lower effective limit

The discussion of the effective lower limit is important. The ELB is the point at which further rate cuts hurt the economy.

The mainstream media did not take note of the discussion about ELB and the constraints it placed on the Fed.

The ECB has gone far beyond the ELB. I believe the Fed did too. But unlike others, I didn’t expect the Fed to cut rates into negative territory.

They did not do it. Indeed, through repurchase agreements and the payment of interest on reserves, the Fed valiantly defended 0.00%.

On September 25, 2019, I commented “The Fed is no longer talking about a zero limit but an effective lower limit. What is the difference ? Where is she ?

Flattening of the yield curve

The mainstream media also failed to note the Fed’s concern about the flattening of the yield curve and how the shrinking balance sheet might impact that flattening.

I would have loved to be in the room for this discussion.

The minutes only tell us what the Fed is willing to admit, not how it said anything or how far it is willing to go.

What will the yield curve look like a year from now?

On December 27, I asked what the yield curve would look like in a year?

I expect reversals if the Fed increases three times and probably sooner, even if the Fed tries to micro-manage the curve to meet its expectations.

Obviously, the Fed is concerned about the flattening and the mainstream media has missed it.

By “micro-managing the curve” I meant that the Fed would manipulate its balance sheet based on duration rather than size, even though it brags about the net reduction.

Yes, the Fed will do everything possible to prevent the curve from flattening.

Including leaks?

But the leaks don’t matter. The curve flattens and will then reverse if the Fed increases enough.


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