The news coming out of the July Federal Open Market Committee (FOMC)
meeting was a reference in the
that the Federal Reserve expected to begin to implement its balance sheet
normalization program “relatively soon,” which we (along with many market
took to mean at the upcoming September meeting. In the minutes of July’s meeting, released Wednesday, we learn that the Fed indeed wanted to “clarify the
time at which” it expected to begin this drawdown process and inserted the
“relatively soon” language for that purpose.
So while there is no additional hint in the minutes that the FOMC has
agreed to make a balance sheet announcement in September, that continues to
be the most likely outcome – barring actual or expected market turmoil
arising from concerns over U.S. policymakers extending the debt limit or
funding the government.
Balance sheet news unlikely to rattle markets
In any event, PIMCO does not expect the formal balance sheet announcement
(whenever it happens) to be a significant market event. This is because the
Fed’s plans –
which we’ve discussed before in this blog
– have been well-telegraphed and specifically designed to minimize market
disruption: The Fed will set caps on the maximum roll-off of
mortgage-backed securities (MBS) and U.S. Treasuries taking place each
month. As we’ve noted, even after the balance sheet is allowed to begin to
shrink, the Fed will continue for up to a year to be
a big buyer in the MBS and Treasury markets
as it seeks to enforce these caps.
The July minutes were silent on the ultimate destination for the size of
the Fed balance sheet. We expect this important decision will be left to
the next Fed chair, or to Janet Yellen in her second term if she is
Inflation and the next rate hike
July’s minutes were perhaps most revealing on the growing concerns within
the FOMC over the
framework, which undergirds the baseline expectation of “most participants”
that U.S. inflation will pick up over the next couple of years and
stabilize “around the Committee’s 2% objective over the medium term.”
However, after four (at the time of the meeting, and now five) consecutive
downside misses versus the consensus forecast for the consumer price
index (CPI), inflation doubts seem to be creeping into the Eccles Building. Indeed, “many participants” now see “some likelihood” that inflation may remain below 2% for longer than they currently expect. But others, we are
told, “expressed concerns about the possibility of substantially
overshooting full employment.”
For now, these opposing views among Fed policymakers appear to be canceling
each other out. Whether or not the Fed hikes one more time this year, as
the “dot plot” released in June indicated they might, will indeed be data – especially
inflation data – dependent.
Visit PIMCO’s Rise Above Rates page for our most up-to-date outlook for interest rates and insight into how we expect financial markets to be affected.
Richard Clarida is PIMCO’s global strategic advisor and a frequent contributor to the PIMCO Blog.