The FOMC Minutes … Market vs Fed Expectations and Defining “Patient”

• The Federal Reserve – Minutes of the Federal Open Market Committee
  “While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased. Several participants indicated that they expected slower economic growth abroad to negatively affect the U.S. economy, principally through lower net exports, but the net effect of lower oil prices on U.S. economic activity was anticipated to be positive.” The idea is that the FOMC upped it concerns with overseas growth, which is logical but hardly new. The notion here is that 1) they lowered assessments and 2) raised expections for ECB and other centrals responding. This is not the Fed responding of course but ipso facto if the ECB doesn’t than the Fed might push tightening out. We don’t think the Fed is trying to send a cryptic message. Rather, they’re saying they expect something from Europe and by couching this all with lower oil price impact being positive we’d wouldn’t read much dovishness into it. That said, since we last wrote 2s/5s is a bit steeper, 5s/10s a bit flatter.

• Bloomberg.com – Fed Minutes Show Rate Rise Unlikely Before April
  The Federal Reserve confirmed that being “patient” on interest rates means no increase before late April, while expressing concern that inflation might continue to linger below its goal. Most members of the Federal Open Market Committee thought a patient stance “indicated that the committee was unlikely to begin the normalization process for at least the next couple of meetings,” according to minutes of the Dec. 16-17 gathering released today in Washington. The minutes indicate broad support for Chair Janet Yellen’s assessment of the likely timing of the first interest-rate increase since 2006 that she delivered at a press conference following the meeting. Officials also discussed risks from overseas, including a plunge in oil prices, and concluded they were largely offset by domestic strength. “The base case for policy remains that sometime in the middle of the year we should begin lifting off,” said Roberto Perli, a former associate director of the Fed’s Division of Monetary Affairs, who is now a partner at Cornerstone Macro LP in Washington. The Standard & Poor’s 500 Index rose 1.1 percent to 2,024.00 at 2:51 p.m. in New York. The benchmark 10-year Treasury yield rose one basis point, or 0.01 percentage point, to 1.95 percent.

Comment

YELLEN:  So I — I did say that the statement that the committee can be patient should be interpreted as meaning that it is unlikely to begin the normalization process for at least the next couple of meetings.

QUESTION:  Binyamin Appelbaum, New York Times.

Does a couple mean two? And when you talk about reasonable confidence in inflation expectations, can you elaborate a little bit about what it would take to give you reasonable confidence that inflation is headed back to 2 percent?

YELLEN:  So, a couple — I believe the dictionary probably says a couple means two, so a couple means two. And with respect to inflation — our forecast for inflation and inflation expectations, let me start by saying I think it’s important that monetary policy be forward looking.  The lags in monetary policy are long.  And therefore, the committee has to base its decisions on how to set the federal funds rate looking into the future.

She could not have been any clearer as to what “patient” means, yet Fed watchers continue to torture this phrase into a more complicated meaning. Craig Torres, who covers the Fed for Bloomberg, offered the following thought yesterday:

FOMC defines “patient.” It means flexible. Foot-drag if the data is strong, stall if the data is weak. Watch the data is the message.

— Craig Torres (@ctorresreporter) January 7, 2015

Minutes use `next couple of meetings’ phrase Yellen used in her opening statement. I find that odd, and not reflective FOMC diversity.

— Craig Torres (@ctorresreporter) January 7, 2015

The highlighted passage in the Bloomberg story above confirms the Fed does not see a hike before April. Combining that with what Yellen said at her presser, we offered the following thought:

• “Patient” as of the December FOMC statement meant NO rate hike at the January 28 and March 18 FOMC meetings.
• If “patient” stays in the January 28 FOMC statement, then do not expect a hike at the March 18 or April 29 meeting.
• If “patient” stays in the Mar 28 meeting, then any potential rate hike would be pushed beyond the Apr 29 and Jun 17 meetings.

So, if the Fed is planning a June hike, they will drop “patient” at the March 18 meeting.

As we wrote last month:

Yellen has put Fed policy back on a calendar and has made Fed-watching easy. When “patient” is dropped from the statement, wait two meetings for the first rate hike.

If Torres is correct and patient means “flexible,” the Fed has yet another credibility problem. Does anyone remember the 6.5% unemployment threshold? Should this be the case, and it very well could be, we take it as yet another example that the Fed is terrified of hiking rates because the markets (not the economy) might react poorly.

• Bloomberg.com – Derivatives Show Traders Are Undeterred on Rates by FOMC Minutes
  Derivatives show minutes from the Federal Reserve’s last meeting did little to alter traders’ expectations that policy makers will begin raising interest rates this year. That’s where the similarities on the outlook for rates between the bond market and the central bank ends. Federal funds futures show a 59 percent chance of the Fed raising its near-zero policy rate in September, little changed from before the release of the Dec. 16-17 meeting minutes. For the years ahead, traders see the Fed increasing rates to only about half the 3.75 percent peak level policy makers predict.

The following comes from the minutes yesterday:

A couple of participants remarked on the apparent disparity between market-based measures of expected future U.S. short-term interest rates and projections for short-term rates based on surveys or based on the median of federal funds rate projections in the SEP. One participant noted that very low term premiums in market-based measures might explain at least some portion of this gap. Another possibility was that market-based measures might be assigning considerable weight to less favorable outcomes for the U.S. economy in which the federal funds rate would remain low for quite some time or fall back to very low levels in the future…

<Click on chart for larger image>

The interesting question is, “does the Fed think the market is wrong or is the Fed doubting itself because the market says something different?“

Our belief is the Fed is starting to doubt itself because it is afraid to upset the markets. Obviously this is conjecture, but we are looking for Fed officials to address this vast difference in rate expectations. The minutes state the Fed is not only aware of this difference, but is also actively discussing it.

• MoneyBeat (WSJ Blog) – In Minutes, Fed Tells ECB What to Do Without Telling It What to Do
  With the release of the minutes from its last meeting Wednesday, the Federal Reserve found a subtle way to tell the European Central Bank what it thinks it should do without seeming like it’s actually telling the ECB what to do…Today, in the minutes to that meeting, we learned in fact that “many participants regarded the international situation as an important source of downside risks to domestic real activity and employment.” But we were also told that although “some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased.” In other parts of the statement, too, there were references to “market participants’” expectations that European monetary policy would be eased. Thus, what is widely thought to be the FOMC’s consensus view – that a sovereign bond-buying form of quantitative easing from the ECB is desirable, because it would offset the liquidity-crimping effect of its own plans to tighten in U.S. monetary policy in the months ahead – was expressed as the expectations of faceless “participants.” The Fed can’t be accused of meddling in a foreign country’s sovereign policy concerns, but at the same time the message seems clear that if the ECB doesn’t act, many U.S. central bankers believe they could be left in a difficult situation. The question now is: What impact will this extremely subtle message have on the ECB, at its own, hotly anticipated policy meeting on Jan. 22?