FOMC Minutes: Fear of quantitative easing
The minutes from the Federal Reserve’s open market committee (FOMC) January meeting suggest that the committee is preparing itself and the markets to decrease asset purchases. A majority of committee members seem to be happy with quantitative easing as it has helped to keep inflation up near its long-run goal of two percent, growth is moderate and housing markets show signs of life. But there are some dissenting voices. The key outtake is:
However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound, but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy. A few also raised concerns about the potential effects of further asset purchases on the functioning of particular financial markets, although a couple of other participants noted that there had been little evidence to date of such effects. In light of this discussion, the staff was asked for additional analysis ahead of future meetings to support the Committee's ongoing assessment of the asset purchase program.
This means that the next FOMC meeting in Mar-19-20 will be highly interesting, and the official’s statements and speeches will be combed thoroughly before that date. As I wrote after the meeting on Jan-31:
Approaching the destination will at least force the Fed to reveal its plan for landing the QE-plane. The fuel (balance sheet toleration) is running out, the destination is approaching (unemployment level) and the crew is getting restless (growing dissent, end of Bernanke’s term). The Fed will have to land soon, so fasten your seatbelts.
Still more from the FOMC minutes:
Several participants emphasized that the Committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved. For example, one participant argued that purchases should vary incrementally from meeting to meeting in response to incoming information about the economy. A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred. Several others argued that the potential costs of reducing or ending asset purchases too soon were also significant, or that asset purchases should continue until a substantial improvement in the labor market outlook had occurred. A few participants noted examples of past instances in which policymakers had prematurely removed accommodation, with adverse effects on economic growth, employment, and price stability; they also stressed the importance of communicating the Committee's commitment to maintaining a highly accommodative stance of policy as long as warranted by economic conditions. In this regard, a number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer period than envisioned in the Committee's exit principles, either as a supplement to, or a replacement for, asset purchases.
This does not sound like the "open-ended” and threshold-based policy the Fed promised us in December. The FOMC seems to know that the risk-reward ratio of the QE is high – the effectiveness of the program is limited, while the risks arising from the eventual exit grow with every additional purchase. Also remember that the participants know that the minutes will be published – I believe the dissenters were somewhat holding back their criticism and were team players at the end of the day.
On the other hand, during the time of the meeting, Europe seemed to be “solved” – at least on a cash flow basis, as sovereign auctions went well and yields were low, even though balance sheet issues were still largely unsolved. Should Europe take a turn for the worse, the FOMC would surely switch to a more dovish mode.
So what will be the market’s reaction after sleeping on it? I guess most participants already knew that the FOMC has dissenters, and that QE has gone on for perhaps too long for the Fed’s taste. EURUSD is currently sitting at levels where I would rather be a short-term buyer: a move lower would in my opinion reverse the EURUSD’s bull trend (earlier squawk on technicals). After the current levels, the next support area is 1.3280-1.3230. The pair has been very choppy due to the GBP and JPY largely driving the show. Instead of using predetermined levels, I would watch overbought/oversold indicators on multiple timeframes and fade breakouts. The month of February has been spent in a zigzagging falling pattern, which could be interpreted as a flag formation within the long-term uptrend. But no longs before an hourly base.
The minutes on Federal Reserve’s website
Previously from me:
Jan FOMC Preview