Published: Sun, April 09, 2017
Markets | By Terence Owen

Fed minutes reveal debate over inflation and Trump

Fed minutes reveal debate over inflation and Trump

The minutes recorded the views of policymakers expressed at a March 14 - 15 meeting, when they voted to raise their benchmark interest rates to head off mounting inflation.

Most members judged that changes to the reinvestment policy would likely be appropriate later this year which would allow the balance sheet to shrink.

But if we are correct in expecting a larger number than the 180k now expected, then we could see volatility spike as the market reaction could go one of two ways: will a stronger payrolls report support an earlier normalisation of the Fed's balance sheet, which could be bad for risky assets, or will the market see it as a sign of economic strength helping risk to rally?

"Nothing is set in stone yet, but this process of changing the reinvestment policy is likely to begin later this year, which is perhaps a little sooner than most in the markets were anticipating", Capital Economics Chief Economist Paul Ashworth said. Fed is still on track [with] three rate hikes in total this year.

In order to stimulate growth, the Fed bought Treasury and mortgage-backed bonds on an unprecedented scale during and after the 2007-2009 recession to help keep interest rates low.

The Federal Open Market Committee released the minutes of their March meeting late Wednesday, which revealed its plan to shed $4.5 trillion worth of bonds now held by the U.S. central bank. It added that any decisions should be conveyed to markets before being implemented.

During that time, the Fed's holdings rose from less than $1 trillion to $4.5 trillion. Financial markets have been watching for any Fed signal on the timing of reductions in the bond holdings.

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The statement comes at a time when the uncertainty of Trump's ability to follow through on his economic promises is growing.

The minutes from the Fed's March meeting showed continued uncertainty about how the White House's policies would affect the economy, with only about half of the Fed's voting members incorporating assumptions about fiscal policy into their economic projections.

Most believed Trump's plans had the potential to boost growth. The stocks that would benefit most from Trump's plan to cut taxes have been lagging after efforts to get his healthcare reform bill stalled.

On inflation, the minutes showed that some officials anxious that if unemployment, now at a low 4.7 percent, fell further, it could pose a "significant upside risk" of higher inflation. The Fed also signaled that it believed that the labor market was near or at full employment and that it has almost met its inflation target.

Some Fed officials thought the inflation target might be achieved by year's end. It was observed that prices of other risk assets, such as emerging market stocks, high-yield corporate bonds, and commercial real estate, had also risen significantly in recent months.

"Raising the fed funds rate a quarter of a point every now and then is tinkering at the edges compared to the elephant in the room that is the balance sheet", said ANZ Bank New Zealand senior economist Sharon Zollner, in a note.

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