I will no longer comment on the bulk of the FOMC minutes. They focus on the Fed staff’s and FOMC members’ views of the economy and the markets. Why bother with that? The Fed makes policy on an ad hoc basis based on whatever happened in the markets in the weeks immediately prior to the meeting. Forward guidance is therefore meaningless and so analyzing the propaganda about the Fed’s decision process is a waste of time.
We have known for years that the Fed is clueless in forecasting the direction of the economy, and in even correctly identifying its current status. The Fed’s process has been to repeatedly revise its forecasts to attempt to hit, what is for them, an elusive moving target, which they never do. It is pointless to parse their words on this process because if the markets crack or if problems crop up in Europe or China which the Fed did not foresee, which it never does, then it will make its policy decision on that basis.
The market’s appearance of front running the Fed is a mirage anyway. The US markets rise and fall on the basis of actual liquidity flows, not what some players imagine those flows might be by trying to imagine what Fedheads would imagine might be coming. It’s a case of imagining the imaginary imaginings of the imaginary. It’s mystical fantasy all around.
What’s more, the Fed’s descriptions of the process are pure propaganda designed to manipulate investor behavior. Attempting to attach meaning to the Fed’s propaganda on its mystical fantasies is an exercise in futility, and I won’t engage in it.
I will review the minutes for any discussion of exactly how they intend to execute their present and future policy decisions, with a particular focus on how they intend to influence interest rates and any changes in the size of the Fed’s balance sheet. These are the issues that matter. But they will only really matter when the Fed actually begins to implement them.
So the only relevant issue in the current release of the minutes for the mid September 2015 FOMC meeting was that the Fed would continue to roll over maturing Treasuries and Agency paper and would continue to purchase MBS in amounts needed to replace those being paid off. This will keep the balance sheet level at the enormous size reached as a result of QE.
The Fed views this as being accommodative and supportive of economic growth. I view it as neither, but the ongoing MBS purchases will continue to liquefy the Primary Dealers to a limited degree each month, which provides limited support for stock and bond prices. Because the amounts are diminishing, so is their ability to support prices. Given the reduction of Fed printing, the other market liquidity factors which we track assume ever greater importance.
The Treasury is not issuing net new supply, and is actually paying down debt right now. That is a temporary bullish influence. But when Treasury borrowing resumes after the debt ceiling is raised, supply pressure will return, and that should have a negative impact on stocks. With the Fed still doing some printing to replace its MBS holdings that are redeemed, the negative effects should be muted, particularly because the ECB and BoJ are still pumping funds into dealer accounts at a breakneck pace. The US markets will remain the most favored receptacle for that liquidity, unless and until crisis conditions cause dealers to redirect the funds to deleveraging their own balance sheets.
That can happen, and we’ll be on the lookout for it.
The minutes had a discussion of how and under what conditions the Fed might eventually begin to reduce the size of the balance sheet by ceasing reinvestments in maturing securities. They said that they intend to wait until interest rates have lifted off, which is absurd. I have continuously held that interest rates can’t rise until the oversupply of cash in the system is first reduced. The idea that they can cause rates to rise first, and then reduce the supply of excess reserves, is putting the cart before the horse.
Furthermore, I view any meaningful reduction in the size of the balance sheet to be virtually impossible because I believe that any action that causes additional Treasury supply to hit the market would put downward pressure on stock prices. The US Government would need to sell additional bonds and notes to the public to replace the paper which the Fed did not roll over. Given the fragility of the world economy and financial system, this is a non starter. If the Fed even timidly experiments with shrinking its balance sheet, I believe that the negative market effects would be immediate, ending the experiment.
We won’t know for sure unless they try, but they’ll first try talking about it. Before they do it, Fedheads will be trotted out to release trial balloons into the ether. Even the Chair herself would probably broach the subject. My guess is that the market will quickly send a message, “Fuhgeddaboutit,” and they will.
The non committal gobbledygook in the minutes, of “maybe we will, maybe we won’t” let maturing paper roll off the balance sheet rather than rolling it over, depending on economic and market conditions, is meaningless right now. It will matter only when they decide to actually do it.