Inside the Fed Minutes

Financial media outlets are focusing on the interest rate decision and possible start of balance sheet reduction, but two other critical notes are being ignored

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Aug 17, 2017
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Much of the financial media has reported and re-reported the recent release of the minutes of the latest Federal Open Market Committee (FOMC) meeting, centering commentary on a possible start for the paring of the Fed balance sheet in September. While key paragraphs in the 6,700-word release do suggest the planned shrinking of the Fed’s $4 trillion balance sheet of mortgage-backed securities and U.S. Treasures will begin next month, there are two other points that have been glossed over and ignored by reporters.

First was a surprising dispute over the accuracy of inflation data and the way it is calculated for the purposes of setting monetary policy (emphasis added):

"A number of participants noted that much of the analysis of inflation used in policymaking rested on a framework in which, for a given rate of expected inflation, the degree of upward pressures on prices and wages rose as aggregate demand for goods and services and employment of resources increased above long-run sustainable levels. A few participants cited evidence suggesting that this framework was not particularly useful in forecasting inflation."

In other words, FOMC participants admitted higher inflation expectations do not necessarily correlate with higher wages and higher aggregate demand. Although the committee was actually pondering how low inflation could be coupled with low unemployment, it is also possible aggregate demand falls but prices rise anyway in a mirror image to what we have now. If inflation measures are not particularly useful, then stagflation also becomes a possibility. The term “stagflation,” however, cannot appear in minutes like these because it is likely to attract unwanted headlines like “Fed Worried About Stagflation."

A second point not widely reported about the minutes is FOMC members are worried about the bond market:

"A number of participants pointed to potential concerns about low longer-term interest rates, including the possibility that inflation expectations were too low, that yields could rise abruptly, or that low yields were inducing investors to take on excessive risk in a search for higher returns."

A sudden and abrupt rise in long-term treasury yields would wreak havoc on the federal government’s ability to service its $20 trillion debt load. Such a development could force the Fed to embark on a new round of quantitative easing.

Regarding the widely-reported imminent beginning of the Fed’s balance sheet reduction plan, the main difference between the most recent FOMC meeting and the one before is that, “Members agreed that, at this meeting, the Committee should further clarify the time at which it expected to begin its program for reducing its securities holdings in a gradual and predictable manner.”

That is, even FOMC members are beginning to get a little impatient about the beginning of this long-awaited balance sheet reduction program. The fact the wording says “Members agreed” rather than “Some members noted…” indicates possible unanimous consent that at least a firm date should be agreed upon by the next FOMC meeting. It seems highly likely we will either get an official announcement of the program’s beginning at the next meeting or an exact date will be announced by the meeting’s conclusion on Sept. 20.