FOMC Minutes Preview: Is The “Symmetric” Fed About To Become Less “Accommodative”?

Today at 2pm EDT, the Fed will release the minutes from the FOMC meeting held on May 1/2 in which it held rates but tweaked its guidance on inflation.

While comments on the natural rate and the yield curve will be of particular focus, Bloomberg notes that per John Williams, the Fed’s era of pledging easy monetary policy may be coming to an end, and today’s minutes could reveal if Williams’ colleagues agree. Meanwhile, as RanSquawk adds, while the release isn’t expected to be a major market mover, it may have a hawkish tilt.

Some other observations on what to expect, courtesy of RanSquawk:

RATES: At the FOMC’s May meeting. the central bank kept rates unchanged at 1.50-1.75%, as expected. The Fed has already hiked once in 2018; in its March economic projections, it pencilled in three rate rises in 2018, and money markets are pricing this trajectory with over 90% certainty; there are also risks of a fourth hike, which markets are assigning a probability of just over 50%.

MAY STATEMENT: The statement, however, saw a few crucial tweaks. The Fed now characterises inflation as “moved close” to 2% (previously it was described as “continued to run below 2%”), and additionally, it added word “symmetric” with regards to its inflation target, which traders eventually interpreted as the idea that the Fed would be prepared to allow an overshoot of inflation without taking aggressive action to rein in price pressures.

“The Fed was much gentler with their inflation tweaks than they could have been in the May statement. This is part and parcel of not wanting the market to read too much into changes that are coming at a non-press conference meeting (i.e. Chairman Powell is not there to talk market participants off the ledge),” RBC writes, “but with that said, the mark-to-market on inflation continues to trend up.”

Fed officials themselves seem to be more tolerant of temporarily higher inflation, with the outgoing NY Fed President Dudley (voter) arguing that an overshoot would not be an issue; even the more dovish contingent, like Bostic (voter) have acknowledged that inflation will likely be above 2% for a while. Fed’s Harker (a non-voter, and representative of the middle ground on the Fed) has endorsed three hikes in 2018, though says he would favour a fourth if inflation runs away (though he does not see that happening just yet), and even the hawkish Mester (voter) does not expect inflation to pick-up sharply, and endorses a gradual rate hike path.

NATURAL RATE OF INTEREST: Analysts will also be watching for discussion on the neutral rate, which most FOMC participants have been reticent to revise upwards in their forecasts (a recent paper by the Fed’s Williams suggests that the natural interest rate is lower than in history, largely on the back of demographics, sluggish productivity, and the demand for safe assets). Williams himself (voter, and incoming NY Fed President) has suggested that the Fed may need to overshoot the rate, which some have noted is typical in hiking cycles. “The market currently has the Fed stopping near the lower end of neutral estimates (which is about 2.5% on Fed Funds),” RBC adds, “we think a re-pricing to a steeper tightening path will continue to play out in the months ahead.”

YIELD CURVE: There will also be focus on the Fed’s comments on the yield curve, a subject that has featured heavily within Fedspeak recently, though the FOMC’s thinking has been mixed. Fed’s Bostic (voter) and Bullard (non-voter) have warned that inversion is a scenario that the Fed should prevent given it has historically portended a recession ahead, with the latter suggesting an easier pace of rate hikes to avoid the scenario. The Fed’s Williams, meanwhile, seems more unconcerned, suggesting it is a situation to monitor over the next couple of years, as the signals  shouldn’t be ignored as the Fed is lifting rates.

THE UN-ACCOMODATIVE FED? The biggest surprise would be if the Fed stops pledging an era of easy, accommodative policy. As BBG notes, Williams – the incoming New York Fed president – told Bloomberg in an interview last week that it might make sense to stop pledging “accommodative” policy and a prolonged period of low rates, echoing a debate that surfaced in minutes of policy maker’s meeting in March. As a result, Michael Feroli, the chief U.S. economist at JPMorgan, would “not be surprised” to see some warning in the May minutes if a wording change is coming in June.

Below, as Bloomberg’s Jeanna Smialek notes, are the statement sentences that may be up for review:

“The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.”

“…the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

Any update would reflect that rates have moved from near zero toward more normal levels. But it’s not clear what level represents a neutral rate of interest – a setting where policy neither fosters nor slows growth – adding confusion to the discussion of how and when to amend the language.

In short: these could be the first FOMC minutes in a while which have an outside market reaction, and with the Fed potentially set to remove the market’s training wheels, stocks may not like it.