Federal Reserve officials have mapped out plans to reduce their $4.5 trillion balance sheet, but they’ve left out one key detail: the starting point.
Clues about whether they’ll begin the asset reduction before another rate hike could come from the record of policy makers’ debate last month. Minutes of that June 13-14 meeting will be released at 2 p.m. on Wednesday in Washington.
The Fed lifted rates in June, signaled one more hike in 2017 in updated projections and spelled out how it would begin gradually unwinding its bond portfolio this year. While Chair Janet Yellen told a post-meeting press conference the process could begin “relatively soon,” the central bank has left the precise timing and sequencing a mystery.
Economic data have shown little change since their last meeting, so the minutes should offer an up-to-date glimpse into how officials view the backdrop as they weigh policy decisions. They’ll also kick off a busy few days for Fed watchers, with its Monetary Policy Report due Friday and Yellen’s semi-annual testimony to Congress beginning on July 12.
“The more interesting aspect of the minutes is going to be what they have to say about the balance sheet, and in particular, if they give any hints about the time frame,” said Stephen Stanley, chief economist at Amherst Pierpont Securities in New York.
Investors will be looking for validation of a working assumption that the policy-setting Federal Open Market Committee will commence balance-sheet roll-off in September and wait for December to hike rates. That view is backed up by pricing in federal funds futures contracts, which shows about a 40% probability of a rate hike in December — twice as high as the betting on a move at the September FOMC.
Another topic that could be an important take-away from the June minutes is the level of concern among officials over financial stability after several, including Yellen, spoke out about high asset prices. The description of the discussion last month may shed light on how widely that view is held.
“I don’t think anyone views Janet Yellen as an expert stock picker, but she’s got control of one of the key variables that determines a lot about asset valuations,” Stanley said.
Yellen said equities are now “somewhat rich” by traditional metrics in a question-and-answer session in London last week. Fed Vice Chairman Stanley Fischer had earlier said increased valuations could only partly be explained by an improving economic outlook. San Francisco Fed President John Williams told Australian media he’s worried about complacency among investors, and the stock market “still seems to be running very much on fumes.”
The remarks all occurred over 24 hours and have Fed watchers speculating about whether the commentary is a concerted effort to talk down exuberant prices, or a sign that the Fed will begin to justify its rate decisions with financial stability arguments.
It wouldn’t be surprising to find more color on the discussion in the June minutes: The Fed’s description of its meeting in May showed that some policy makers were alert to high commercial real-estate valuations, and the Fed staff remarked that “asset valuation pressures in some markets were notable.”
“There’s some concern probably, about frothiness in the markets,” said Omair Sharif, senior U.S. economist at Societe Generale in New York.
A lot of attention will be paid to how officials lined up over the debate on recent weak readings on inflation, which has dropped farther below the Fed’s 2% goal.
Data last week showed the Commerce Department’s core index slowed to 1.4% in May. Foreshadowing that decline was a weaker reading from a Labor Department inflation index published on June 14, as Fed officials began the second day of their policy meeting. The FOMC acknowledged in its post-meeting statement that “inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2%.”
That said, the Fed has been listing reasons to view the price pullback as temporary. In her June press conference statement, Yellen noted that inflation had been driven lower by “one-off reductions” including declines in wireless telephone bills and prescription drug costs.
Yellen said 12-month inflation will remain subdued until the very low March 2017 reading drops out of the calculation, a comment that some viewed as an effort to de-emphasize the year-over-year core rate.
“While the Fed, as an aggregate, continues to insist that weakness in core inflation is only temporary, the minutes may reveal a more cautionary assessment from several participants,” Sam Bullard, senior economist at Wells Fargo in Charlotte, N.C., wrote in a research note.
The minutes will also probably discuss unemployment, which is at its lowest level since 2001. The U.S. job openings rate is at its highest level this business cycle and wages are slowly grinding higher, signs that point to an economy at or near full employment.
“There’s a broad consensus that the unemployment rate is below the long-term equilibrium rate, and that they don’t want to see it falling too much further,” said Scott Brown, chief economist at Raymond James Financial in St. Petersburg, Fla.
Because Fed officials believe that low joblessness eventually begets higher inflation, “there is still a pretty good expectation that inflation is going to trend up toward the 2%,” Brown said.
