The market was disappointed over the FOMC minutes for the May meeting. While the minutes should be considered as a confirmation of a rate hike in June, it raised the uncertainty over the future rate hike path. The members appeared divided over the inflation outlook. While one camp was concerned over the impact of falling unemployment on inflation, another camp remained focused on the downside risk to inflation. Meanwhile, it is getting more likely that the balance sheet reduction might begin ‘this year’.
On the upcoming rate hike, the minutes suggested that ‘most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation’. It is highly likely that a rate hike would be adopted in June. However, the path after that is now more uncertain. The Fed reiterated its data-dependent stance on the monetary policy outlook. As suggested in the minutes, ‘members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation’. The market has priced in over 80% of a rate hike next month but expects less than 2 more rate hikes from now towards the end of the year.
Another focus is the agenda on the balance sheet reduction. The minutes unveiled that a briefing on the possible operational approach to balance sheet reduction was provided, aiming at reducing the central bank’s securities holdings in ‘a gradual and predictable manner’. The minutes suggested that, under the proposed approach, ‘the Committee would announce a set of gradually increasing caps, or limits, on the amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month’.
The minutes went on to explain that ‘as the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalized’.
The minutes suggested that ‘nearly all policymakers indicated that as long as the economy and the path of the federal funds rate evolved as currently expected, it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year’. The timing comes earlier than our, as well as the market’s, expectations that the plan on balance sheet reduction would be announced in December this year.
