Edition #4 - Highlights of the FOMC Minutes
Released on 5/19/2021, from the Policy Meeting on 4/27 & 28
Yesterday afternoon, at 2:00pm ET, The Federal Open Market Committee (FOMC) distributed the minutes of their policy meeting held on April 27-28, 2021. The release of the minutes, as well as other key press releases from the Federal Reserve, are market-moving events which cause yields to dramatically shift & impacts the present value of nearly every asset. The FOMC is the arm of the Federal Reserve that is responsible for making monetary policy decisions & carries out open market operations (OMO) to accomplish their economic goals. According to the New York Fed, the FOMC is required by law to meet four times per year but has set a precedent to meet about every six weeks, or eight times per year. These policy meetings are extremely important, with the bond market & equity prices hanging on nearly every word of the FOMC’s policy statement & the meeting minutes that are released three weeks after the FOMC’s policy meeting.
The press release from the policy meeting is extremely concise (typically 4 pages at most & less than 1,000 words), stating the primary talking points of the meeting, decision to raise/maintain/lower the Federal Funds Rate (FFR), and provides some info on asset purchases/selling activity. On the other hand, the release of the minutes is often a deep-dive into the current state of economic conditions, financial markets, & a great commentary for where we might be in the business/credit cycle. The minutes often discuss the opinions & concerns of the FOMC participants, help to give insights into the qualitative/quantitative discussions & thought processes.
Despite knowing that golden nuggets are bountiful in these releases, they’re usually too dense & dry for most financial professionals to want to read the entire release (they’re typically between 8,000 to 12,000 words). Even for someone who is enthralled by monetary policy, they are extremely dry reads. Nonetheless, I always read at least 50% of each of the minutes, focusing on some of the key sections & my main topics of interest. As such, there’s clearly interest to get the key takeaways from the report, which is why I’ll be providing the summary write-ups as a way to bridge that gap. I’ve always been disappointed with the way that legacy financial news covers the minutes, as I don’t feel they give an accurate & complete representation of the FOMC’s rhetoric, criteria for policy changes, or evaluation of the economy. As such, this is a great platform to provide the key takeaways from the FOMC minutes going forward, where I will give a fair & accurate representation of the FOMC’s comments while providing my own commentary & analysis of the minutes.
In the future, these key highlight reports will not be free, but I wanted to provide an example of what these will look like going forward so that readers can gauge the value that it provides. As I highlighted before, I believe the minutes are full of key economic discussions/updates, with broad-market impacts due to the effect on yields. Essentially, all asset prices are impacted by the Federal Reserve & these FOMC minutes. I’m hopeful that the knowledge of the key highlights from the meeting, you’ll be able to better understand how your portfolio is being impacted by economic conditions & monetary policy. With that said, let’s dive right into the FOMC minutes, released on 5/19, from the policy meeting held on April 27-28, 2021. I will include some brief commentary to supplement the minutes, which will be denoted in italics.
Developments in Financial Markets & Open Market Operations:
Financial conditions “eased moderately” over the 8 week period since the prior meeting, citing that the implosion of “a highly levered family investment office” (Archegos Capital) had limited impact to the broader financial market.
Yields on long-term Treasuries have declined, despite strong expectations for U.S. economic growth & upward revisions. With yields rising higher YTD, the market remains flush with demand from “foreign institutions, pension funds, and insurance companies”.
The Open Market Desk’s surveys of primary dealers & market participants indicate that respondents have “increased the probability [of] higher yields at the end of 2021”. No surprise here. As I pointed out in the 5/19 newsletter, I fully expect nominal yields to increase for the majority of the year; however, I’m not sure how much higher they will move.
With respect to policy outlook for the FOMC, the trajectory of the FFR is little changed, implying that the “target range would gradually increase to a level just over 2% in 2026”. In light of market fears that the Fed will need to raise interest rates faster than expected, this is exactly what I want to hear the FOMC reiterate: a steadfast & patient approach to raising rates. Keep in mind that they typically increase rates at a pace of +0.25 basis points per meeting during their hiking cycles.
In regards to the Fed’s balance sheet, reserve balances have continued to increase and reached an ATH of $3.9Tn, versus a pre-pandemic level of $1.7Tn in February 2020. To me, this indicates that commercial bank lending is stagnant relative to the amount of liquidity that was added to the financial system. In fact, Loans & Leases in bank credit has only increased +2.9% YoY as of February 2021, meanwhile the total assets of commercial banks increased by +15.3% over the same period (of which 56% of the increase in assets was driven by increased cash holdings). I expect this trend will continue.
Staff Review of the Economic Situation:
While U.S. GDP grew at a faster pace in Q1 2021 compared to Q4 2020, the labor market has “remained well below its level at the start of 2020”.
While labor market conditions have improved, notably for non-farm payroll employment, unemployment rate, initial claims for unemployment insurance, and the labor force participation rate, there’s still slack.
Average hourly earnings rose by +4.2% in March YoY, but the committee notes that this is largely due to the continued changes in the composition of the workforce. “In particular, the concentration of job losses among lower-wage workers”.
The YoY change in the consumer price index (CPI) was +2.6% for March 2021; however, the Core CPI inflation (which excludes food & energy prices) was +1.6% over the same period.
Investments for equipment and intangibles increased in the Q1 2021, but “at a slower pace than that seen in the fourth quarter of 2020”. There is still uncertainty about the longer-term effects of the pandemic.
Staff Review of the Financial Situation:
While “market-based financing conditions remained accommodative and bank lending conditions eased…,lending standards for commercial & industrial and consumer loans remained tighter than pre-pandemic levels”. It seems that banks are remaining precautious in terms of extending their balance sheet to their clients’ long-term projects & financing needs.
Technology & consumer discretionary stocks outperformed the broad stock market. The Nasdaq-100 rallied +15% from the 3/5/21 lows through 4/27, but has since fallen more than -7% since then.
“The effective FFR and SOFR (secured overnight funding rate) were little unchanged, averaging 0.07% and 0.01%… over the inter-meeting period”. I suspect these rates will remain at these levels for at least the next 12-18 months.
Over the first quarter of 2021, senior loan officers indicated that banks were “easing standard, on net, for C&I loans across firms of all sizes”. Additionally, banks “reported that demand for C&I loans weakened at large & middle-market firms”. I am not surprised to hear this, considering that bank reserves are at all-time highs. Banks are in the business of lending, connecting savers & borrowers to finance economic activity & investment. They want to lend if risks are properly mitigated. While it’s encouraging (although slightly concerning) that their lending standards are easing, it will be necessary to help foster more business investment in the short & intermediate term.
Delinquency rates for hotel & retail mortgages in commercial mortgage-backed securities remained elevated.
The residential mortgage market remains accommodative for “stronger borrowers”, while staying tight for those with lower credit scores. Although the average 15 & 30 year fixed mortgage rates remain near the all-time lows from 1/7/2021.
Staff & Participants’ Views on Current Conditions & the Economic Outlook:
“With the boost to growth from continued reductions in social distancing assumed to fade after 2021, GDP growth was expected to step down in 2022 & 2023. However, with monetary policy assumed to remain highly accommodative, the staff continued to anticipate that real GDP growth would outpace that of potential…, leading to a decline in the unemployment rate to historically low levels”. I think this is the key statement from these minutes, as it indicates that the Federal Reserve will continue to provide monetary stimulus to support the weaker aspects of the U.S. economy (even if that allows for inflation to run higher than 2% for an extended period of time). It makes me question if the Fed will truly wait to raise rates until the unemployment rate falls back to the all-time lows that existed just before the pandemic, at 3.5% in February 2020.
The outlook on inflation has remained unchanged, with the goal & expectation for the “12-month changes in total and core PCE prices… to move above 2%”. The minutes note that “bottlenecks, supply disruptions, and historically high rates of resource utilization” posed a threat for higher-than-expected inflationary pressures.
Participants “noted that the economy remained far from the Committee’s maximum-employment and price-stability goals. This echos what I wrote in the first bullet-point above: so long as the U.S. economy is below full-employment (notably measured by the unemployment rate, currently at 6.1%) & inflation has not sustainably remained above 2%, the Fed will not hike rates & will continue to support the economy as necessary.
Fiscal stimulus, accommodative financial conditions, and reduced social-distancing measures would continue to support consumer spending, also noting the “elevated level of accumulated household savings”.
Per the business connections of the FOMC members, employers are “having trouble hiring workers, likely reflecting factors such as early retirement, health concerns, childcare responsibilities, and expanded unemployment insurance benefits”. My opinion is that the unemployment insurance & childcare responsibilities are the most prominent of these 4 factors.
Committed to their previously outlined outcome-based based guidance based on “observed progress toward the Committee’s goals, not on uncertain economic forecasts”.
Some members of the FOMC noted concerns of letting “inflation pressures build up to unwelcome level before they become sufficiently evident to induce a policy reaction” (ie. raise rates). I’m pleased to see that members of the FOMC are airing their concerns about inflation running above historical levels for a sustained period. There’s a common saying in finance/economics that “you can’t put the genie back into the bottle” as a way to highlight how it can be extremely difficult/painful to reduce inflation once it starts to run rampart. Recall, to combat double-digit inflation in the 1970’s, Paul Volker increased the FFR to record-high levels that fluctuated between 13% and 20% for years. As a frame of reference, the current FFR is an average of 0.07% as noted above under “Staff Review of the Financial Situation”.
Committee Policy Action:
Purchase $80Bn/month of Treasury securities & mortgage-backed securities by $40Bn/month (both are at record-high paces), in order to “sustain smooth functioning of markets”. This indicates that the Federal Reserve’s balance sheet will continue to grow, keeping interest rates at historical lows, and reaffirms my positivity on dollar-denominated assets (notably equities, real-estate, tangible assets/commodities, crypto).
There are many items that were discussed at great length in the meeting minutes. This newsletter is simply a high-level overview of what I found to be the most important items, with some personal commentary to add color. The full release of the minutes can be found here.
Until tomorrow,
Caleb Franzen