What you need to know from the December FOMC minutes

  1.  ‘The staff reported that they saw potential benefits to extending the exercise (overnight reverse repurchase agreement (ON RRP) operations) and in January would likely recommend a continuation along with possible adjustments to program parameters that could provide additional insights into the demand for a potential facility and its efficacy in putting a floor on money market rates.’
  2. Proposed increase of 300% in cap on individual allocations in ON RRP was recommended and ‘A few participants suggested that it would be useful to evaluate the potential role of an ON RRP facility in the context of the Committee's plans for monetary policy implementation over the medium and longer term.’
  3. ‘The staff presented a short briefing summarizing a survey that was conducted over the intermeeting period regarding participants' views of the marginal costs and marginal efficacy of asset purchases.’
    1. ‘Most participants judged the marginal costs of asset purchases as unlikely to be sufficient, relative to their marginal benefits, to justify ending the purchases now or relatively soon;’ – This is certainly an odd way of saying the purchase program is working.  However, they go on – in the same sentence to advice…
    2. ‘a few participants identified some possible costs as being more substantial, indicating that the costs could justify ending purchases now or relatively soon even if the Committee's macroeconomic goals for the purchase program had not yet been achieved.’ – As warned in the October FOMC minutes, the Fed wanted to make sure that economic agents understood if the Fed decided to truncate the purchase program for reasons of efficacy rather than accomplished goals.  A few at least are suggesting efficacy cause for ending.
    3. In total, I read this as indicating that a large majority is on board for ending the purchase program and that some have greater concerns for ending sooner than street consensus estimates for $10B reduction in purchases per meeting.
    4. Finally, ‘Regarding the marginal efficacy of the purchase program, most participants viewed the program as continuing to support accommodative financial conditions, with a number of them pointing to the importance of purchases in serving to enhance the credibility of the Committee's forward guidance about the target federal funds rate.’ – Now we have need for the purchase of up to $75B securities a month to help with creditability in forward guidance.  The Fed must not have a lot of faith in their creditability at this juncture.  That is a very sad statement.  We should however note that after the fact, many programs find ill-advised justifications instead of corrective measures sought.
  4. Staff Review of the Economic Situation
    1. ‘Total nonfarm payroll employment rose in October and November at a faster monthly pace than in the previous two quarters.’- Recognizing accelerated attainment of stated goals.
    2. Also noted…’ The share of workers employed part time for economic reasons declined slightly…’ and ‘The rate of job openings edged up’, ‘four-week moving average of initial claims for unemployment insurance trended down’ and ‘hiring plans remained higher than a year earlier, and household expectations of the labor market situation improved in early December.’ – not a mild show of approval.
    3. ‘Manufacturing production accelerated briskly in October and November after increasing at a subdued pace in the third quarter, and the gains were broad based across industries.’ – Weak manufacturing in Q3 was a very worrisome development and likely cause for Sep Taper delay.
    4. ‘Moreover, recent information for key factors that support household spending was consistent with further solid gains in PCE in the coming months. Households' net worth likely expanded as equity values and home prices increased further in recent months; real disposable income rose, on net, in September and October; and consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers improved significantly in early December.’ – While both improved household employment expectations and sentiment in general improved ‘significantly’, much of recent household wealth gains have been from 30% jump in equity prices.  Percentage of households with equity stake limited and without resultant purchasing power implications.
    5. ‘The pace of activity in the housing sector appeared to continue to slow somewhat’ – and could show further weakness with colder weather of late.  Not to get too jumpy on this and best to see what Q1 brings.
    6. Also ‘subdued in the third quarter’ was ‘Growth in real private expenditures for business equipment and intellectual property products…’ – Best watch this, would expect some expenditures if households are correct in views of jobs prospects and if the inventory drawdown in Q4 is indicative of greater production needs.
    7. ‘Total U.S. consumer price inflation, as measured by the PCE price index, was less than 1 percent over the 12 months ending in October, in part because consumer energy prices declined over the same 12-month period.’ – There appears no need at present to worry about inflation at all. Suspect this will find some variability by year end and Fed will make strong use of transitory development message.
  5. Staff Review of the Financial Situation
    1. ‘Financial market developments over the intermeeting period appeared to be driven largely by incoming data on employment and economic activity that exceeded investor expectations as well as by Federal Reserve communications.’ – hmm, I guess employment and economic activity have indeed exceeded Fed communications…but they are playing catch-up.
    2. ‘Market expectations regarding the timing of liftoff of the federal funds rate seemed to be little changed over the period.’ – Sound the ‘all clear’.
    3. However, ‘In part, a variety of Federal Reserve communications were seen as strengthening the Committee's forward guidance for the federal funds rate and contributing to the stability of expectations for the near-term path of the federal funds rate in the face of an improved economic outlook.’ – I wouldn’t be so sanguine about the power of persuasion when only the ‘near-term path of federal funds’ is noted to have been stable.  I read ‘near-term’ even in forward guidance as less than 1 year.
    4. ‘On net, judging by financial market quotes on interest rate futures, the expected federal funds rate path through the end of 2015 moved only slightly since the October FOMC meeting.’ – As indicated earlier today (Jan 8, ’14), the extent of today’s sell-off and the proximity to the employment data suggest some concern for a changed attitude in the prospects for higher rates…ie we may have tipped the scale and now only question is by how much will rates rise and how quickly…and of course where should one best be short (-5yr / +30yr!!!)
    5. ‘Responses to the December 2013 Senior Credit Officer Opinion Survey on Dealer Financing Terms (SCOOS) suggested that demand for funding for CMBS picked up since September. CRE loans on banks' books expanded in October and November at an increasing pace.’  - Encouraging developments in lending.
    6. ‘In response to special questions in the survey, dealers indicated that the current use of repurchase agreements or other forms of short-term funding for longer-duration assets was roughly in line with or somewhat below the levels seen early in 2013.’ – Good highlighted question.  This is the area Fed Governor Stein pointed to earlier this year in his notice of higher leverage and acknowledgment that policy rate increase gets into all the cracks.
    7. On financial stability, ‘However, the staff report noted that the complexity and interconnectedness of large financial institutions, along with some apparent increases in investor appetite for higher-yielding assets and associated pressures on underwriting standards remained potential sources of risk to the financial system.’ – a bit in line with a heightened interest in ending purchase program for efficacy concerns.
  6. Staff Economic Outlook
    1. ‘In the economic projection prepared by the staff for the December FOMC meeting, the forecast for growth in real gross domestic product (GDP) in the second half of this year was revised up a little from the one prepared for the previous meeting, as the recent information on private domestic final demand--particularly consumer spending--was somewhat better, on balance, than the staff had anticipated.’  - the improvement in private domestic final demand followed some surprising jumps in inventory accumulation that also followed slower manufacturing growth.  These worrisome signs of potential unwanted inventory accumulation have been found unwarranted and rather, inventory gains are a sign of greater confidences.
    2. ‘The staff continued to project that real GDP would expand more quickly over the next few years than it has this year and would rise significantly faster than the growth rate of potential output.’ – close that gap
    3. ‘…slack in labor and product markets persisting over most of the projection period, inflation was projected to be subdued through 2016.‘ – awful good eyesight to see that far.
About the Author

Martin McGuire, managing director at TJM Institutional Services

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