Fed Minutes: Inflation Debate Heats Up, But Markets Shrug

Wondering why there has been so little volatility in the markets the last few months? Read the minutes from the Federal Reserve’s late July meeting and you’ll get a good sense — if you can stay awake that long.

Wednesday’s minutes revealed virtually no new information and elicited almost no market response.

Consider mortgage-backed securities, which could be affected by the Fed’s plans to shrink its holdings. Walter Schmidt of FTN Financial writes:

 We will keep this extremely brief, primarily because there is not much to say. MBS spreads are virtually unchanged in the minutes after the release of the FOMC meeting minutes from July 26. In fact, we have refreshed our screens a few times since 2pm to make sure we are not missing anything, and we are not. The FOMC did not really say much in the minutes that it has not already said in statements, and the market seems to like that just fine.

The yield on the benchmark 10-year note stayed at 2.23% immediately after the 2 p.m. release. After about a half hour, it had inched down 1 basis point. This was a very muted reaction for the Fed minues.

Ian Lyngen and Aaron Kohli of BMO Capital Markets write:

The Treasury market has done little with the release, other than to hold the bid that followed news of Trump’s disbanded Manufacturing Council and Strategy and Policy Forum — further fallout from the President’s comments regarding the violence in Charlottesville.

The only detail they highlight is a fair amount of disagreement about inflation and highlight this passage from the minutes:

Most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term. Many participants, however, saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside.

Krishna Memani, chief investment officer at OppenheimerFunds, agrees the minutes reflect growing  concern about inflation among FOMC members, “but I don’t think as of now it is in the majority,” he tells Barron’s. ” If that trend continues, that may change.”

He doesn’t think the Fed will hike rates in “the foreseeable future” but he does think it will start shrinking its balance sheet this fall, which will have only a marginal impact on markets and go on for a long time. “They want to riase rates, but low inflation is not giving them the opportunity,” he says. “They are deathly afraid of mainking a policy mistake.”

Investors were looking for new details on the Fed’s plans to shrink the balance sheet. But what they got mostly confirmed market expectations that a plan could be announced as soon as September. Here’s a passage on that topic:

Participants generally agreed that, in light of their current assessment of economic conditions and the outlook, it was appropriate to signal that implementation of the program likely would begin relatively soon, absent significant adverse developments in the economy or in financial markets. Many noted that the program was expected to contribute only modestly to the reduction in policy accommodation. Several reiterated that, once the program was under way, further adjustments to the stance of monetary policy in response to economic developments would be centered on changes in the target range for the federal funds rate. Although several participants were prepared to announce a starting date for the program at the current meeting, most preferred to defer that decision until an upcoming meeting while accumulating additional information on the economic outlook and developments potentially affecting financial markets.

Here’s how the minutes describe the broader U.s.  economy:

Meeting participants agreed that information received over the intermeeting period indicated that the labor market had continued to strengthen and that economic activity had been rising moderately so far this year. Job gains had been solid, on average, since the beginning of the year, and the unemployment rate had declined, on net, over the same period. Household spending and business fixed investment had continued to expand. On a 12‑month basis, both overall inflation and the measure excluding food and energy prices had declined and were running below 2 percent.

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