At 2 a.m. Beijing time Thursday, the Federal Reserve released the minutes of its June monetary policy meeting.
The minutes show that the main tone of the meeting is still the need to remain patient in tightening monetary policy. Inflation remains the consensus for the time being, officials are deeply divided over when to scale back bond purchases and methodology, and they expect the U.S. economy to continue to make progress toward reaching the threshold for QE tapering.
“Substantial further progress” criteria have not been met
Some Fed officials believe that the economic recovery is faster than expected, while inflation continues to rise, which provides a reason for the Fed to tighten monetary policy. Several participants mentioned that, in view of the data received, they expect to start reducing the pace of asset purchases conditions will be met earlier than expected at previous meetings.
However, most officials insisted that unless the economy makes further substantial progress, the Fed will not make a major policy shift, and the market must be prepared for the shift, and right now the U.S. economy is not meeting this criterion.
Most officials believe that patience should be maintained in assessing progress toward the target and in announcing QE tapering.
There was general agreement that as a prudent planning exercise, it is important to be prepared to reduce the pace of asset purchases in response to unexpected economic developments, if appropriate.
When and how to scale back bond purchases is widely divergent
Although in the view of hawkish officials, the economy is now close to the tipping point for tapering QE, but some hawkish officials also said that several interest rate meetings are needed to develop and announce plans to reduce bond purchases.
The Fed will continue to buy $80 billion of U.S. Treasuries and $40 billion of mortgage-backed securities (MBS) each month. Officials discussed the issue of MBS purchases, but were divided. Several participants stressed that low interest rates have led to rising home prices and that valuation pressures in the housing market could pose financial stability risks. Given the pressure on home prices, priority should be given to reducing MBS purchases.
In contrast, several other officials said that a balanced reduction in U.S. Treasuries and MBS would be preferable because such an approach would be consistent with the Committee’s previous communications.
At the upcoming meeting, participants agreed to continue assessing the economy’s progress toward the Committee’s goals and to begin discussing plans to adjust the path and composition of asset purchases. They reiterated that they would provide early notice to the market prior to making an announcement on reducing the pace of bond purchases.
Economic outlook uncertainty increases
Federal Reserve officials raised their expectations for economic growth and inflation. Several participants emphasized that uncertainty surrounding the economic outlook has increased and that it is too early to make definitive conclusions about the path of the labor market and inflation.
They acknowledged that U.S. economic activity and employment indicators have strengthened amid progress on vaccinations and strong policy support, that the sectors most affected by the outbreak remain weak but have shown improvement, that overall financial conditions remain accommodative, and that soaring consumer spending has prompted them to raise their forecasts for real GDP growth this year.
Regarding inflation, the prevailing view was that while inflation would spike to 3.4% this year, the rise was seen as largely reflecting temporary factors, and participants expected inflation to decline toward the Committee’s longer-run target of 2%.
The vast majority of participants judged the risks to their inflation forecasts to be tilted to the upside, as supply disruptions and labor shortages are likely to persist longer and could have larger or more lasting effects.
Some participants expressed concern that long-term inflation expectations could rise to inappropriate levels if inflation continues to rise. Officials at the meeting generally agreed that the Fed must act in the event that inflation gets out of control or other risks arise.
Regarding the job market, officials expect conditions to continue to improve, with labor shortages easing throughout the summer and fall as vaccinations continue to advance, social distance policies gradually ease, more schools reopen, and unemployment benefits expire.
However, several officials noted that the economy is still far from meeting its employment goals. Some argued that while recent job growth had been strong, it was weaker than they had expected. A few others cited an uneven labor market recovery.
Some participants judged that the Committee will have information in the coming months to better assess the path of the labor market and inflation.
Participants generally agreed that the recovery was not yet complete and that risks to the economic outlook remained. As a result, the June meeting was left on hold on key monetary policy, such as interest rates and bond purchases, pending more data in the future.
Some participants felt that the upcoming data releases provided less clear signals about underlying economic dynamics. Heightened uncertainty about economic developments also implies significant uncertainty about the appropriate path for the federal funds rate.
Overnight Reverse Repo Pressure to Continue to Increase
The minutes showed that System Open Market Account (SOMA) managers noted that balances in overnight reverse repo instruments will likely continue to grow in the coming months and that at some point it may be appropriate to consider raising the cap on counterparties.
Participants noted that adjusting the Fed’s managed rate would help keep the federal funds rate within its target range. Participants agreed that this technical adjustment was not related to the appropriate path for the federal funds rate or the stance of monetary policy.
Officials also discussed recent trends in short-term funding markets, and they generally supported setting up a U.S. domestic standing repo facility (SRF) and converting temporary repurchase agreements for overseas and international monetary institutions during the epidemic into a standing mechanism.
U.S. Treasury yields edged lower after the release of the Fed minutes, with the 10-year Treasury yield holding at 1.316%, maintaining its intra-day decline of 5 basis points. The dollar index fell slightly, but remained steady above 92.70.
Spot gold was higher in the short term, holding steady above $1,800 per ounce.
U.S. stocks were little changed, with the Dow and S&P 500 maintaining gains and the Nasdaq stopping losses and turning up.
Analyst James Callan believes that although the minutes show that inflation mainly reflects temporary factors, but “uncertainty” is still too high to accurately assess how long inflationary pressures will continue.
Bloomberg economists expect inflation to fall next year, which is largely consistent with inflation expectations and long-term inflation targets, as “many participants” pointed out. Bloomberg analysis also said that the minutes very clearly show that many Fed officials are nervous about the trend of inflation in June, they also believe that the scale of asset purchases will begin to be scaled back earlier than previously expected.
CNBC comments that the minutes of the meeting on the topic of debt reduction basically does not provide any effective information, only to reiterate that officials are “considering the start of discussions taper”, there is little other progress.