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The Bond Market Reacted to Hawkish Fed Meeting Minutes Days In Advance: Why?

Lots of words were spilled today in over the Fed's allegedly hawkish FOMC meeting minutes. Let's go over several things no one else seems to have caught.
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Treasury Yields December 15 to Date 2022-01-05

Hike in March?

The WSJ reports Fed Minutes Point to Possible Rate Increase in March

Minutes of their Dec. 14-15 meeting, released Wednesday, showed officials believed that rising inflation and a very tight labor market could call for lifting short-term rates “sooner or at a faster pace than participants had earlier anticipated.”

FOMC Meeting Minutes Released Today

Let's take a look at the FOMC Meeting Minutes released today, emphasis mine.

Discussion of Policy Normalization Considerations

The participants’ discussion was preceded by staff presentations. The staff reviewed the previous normalization episode, including how the Committee commenced normalization by raising the target range for the federal funds rate and then reducing the Federal Reserve’s asset holdings in a gradual and predictable manner, as well as the timing of these steps.  

The staff presentation included assessments of the implications for the yield curve of alternative settings of the two tools [Rate Hikes and Balance Sheet Reduction], the relative uncertainty of the effects of each tool, and the challenges associated with conducting and communicating policy with multiple tools.  

 Participants generally emphasized that, as in the previous normalization episode and as expressed in the Committee’s Statement on Longer-Run Goals and Monetary Policy Strategy, changes in the target range for the federal funds rate should be the Committee’s primary means for adjusting the stance of monetary policy in support of its maximum-employment and price-stability objectives. This preference reflected the view that there is less uncertainty about the effects of changes in the federal funds rate on the economy than about the effects of changes in the Federal Reserve’s balance sheet.  

[Mish: That last sentence above is amusing given the Fed was hell bent on expanding its balance sheet to the point it was forced to take close to $2 trillion back via reverse repos. Now after padding the balance sheet it is less certain what to do about it.]

 A few participants also noted that when the federal funds rate is away from the effective lower bound (ELB), the Committee could more nimbly change interest rate policy than balance sheet policy in response to economic conditions.  

[Mish: Please note the Fed, unlike the ECB, is very concerned that the ELB is above zero. The ECB cut rates well below Zero. The Fed has concerns]

Participants had an initial discussion about the appropriate conditions and timing for starting balance sheet runoff relative to raising the federal funds rate from the ELB. They also discussed how this relative timing might differ from the previous experience, in which balance sheet runoff commenced almost two years after policy rate liftoff when the normalization of the federal funds rate was judged to be well under way.  

Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the federal funds rate. However, participants judged that the appropriate timing of balance sheet runoff would likely be closer to that of policy rate liftoff than in the Committee’s previous experience.  

[Mish: It took the Fed two full years to begin balance sheet reduction after the last rate hike cycle began. The preceding two paragraphs suggest it will be faster this time.]

Some participants commented that removing policy accommodation by relying more on balance sheet reduction and less on increases in the policy rate could help limit yield curve flattening during policy normalization. A few of these participants raised concerns that a relatively flat yield curve could adversely affect interest margins for some financial intermediaries, which may raise financial stability risks

[Mish: Once again we see Fed worry over yield curve flattening.]

While participants generally continued to anticipate that inflation would decline significantly over the course of 2022 as supply constraints eased, almost all stated that they had revised up their forecasts of inflation for 2022 notably, and many did so for 2023 as well.  

Bond Market Reacted In Advance of the Minutes - Why?

1: Convenient Leak?
2: Lucky Guess or Random Events?
3: New Economic Data? 
4: Brilliant Trading?

I cannot find any evidence of #3 but I suppose I might have missed something.

Regardless or the answer, it is meaningless over long haul, but if it's a leak, it's important, especially to those impacted or front-running the trade. 

Effective Lower Bound

Powell Grasps at Air in search of Inflation Expectations and the ELB

The discussion of Effective Lower Bound is an important one. The ELB is the point at which further rate cuts are detrimental to the economy. 

Mainstream media failed to note the discussion regarding ELB and the constraints it put on the Fed.

The ECB went well beyond ELB. I believe the Fed did too. But unlike others, I did not expect the Fed to lower rates into negative territory. 

They didn't. Indeed, via reverse repos and paying interest on reserves, the Fed valiantly defended 0.00%. 

On September 25, 2019 I commented "The Fed is no longer talking about zero-bound but effective lower bound. What's the difference? Where is it?"

For Discussion please see In Search of the Effective Lower Bound

Yield Curve Flattening 


Mainstream media also failed to note the Fed's concern over yield curve flattening and how balance sheet reduction might impact that flattening.

I would loved to have been in the room for that discussion. 

The minutes only tell us what the Fed is willing to admit, not how they stated anything or to what lengths they are willing to go.

What Will the Yield Curve Look Like One Year From Now?

On December 27, I asked What Will the Yield Curve Look Like One Year From Now?

I expect inversions if the Fed hikes thrice and probably sooner, even if the Fed attempts to micro-manage the curve to meet its expectations. 

Clearly, the Fed is concerned over flattening and mainstream media missed it.

By "micro-manage the curve" I meant the Fed would manipulate its balance sheet by duration as opposed to size, even if it gets to brag about the net reduction.

Yes, the Fed will do whatever it can to prevent the curve from going flat. 

Including leaks? 

But leaks don't matter. The curve is going flat and will then invert if the Fed hikes enough. 

The Fed Expects 6 Rate Hikes By End of 2023 - I Don't and You Shouldn't Either

I discuss projections in The Fed Expects 6 Rate Hikes By End of 2023 - I Don't and You Shouldn't Either

But the fact remains There is No Predictive Power in Fed Projections

Thanks for Tuning In!

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