The January meeting just concluded of the Federal Open Market Committee meeting looks to have gone as smoothly as could be hoped for, judging by the seemingly minor but important changes to the statement, and even more so by Chairman Jerome Powell’s deft handling of the presser, particularly his avoidance of messaging missteps on the balance sheet issues that should safely wash away fears of a repeat to the 2013 taper tantrum, at least on rates.
** First, in terms of the rates stance, we drew the most significant takeaway today from the January statement in its modest — one wants to say optimistic, certainly confident — tweak to the inflation language. Current monetary policy is presumably seen as still accommodative enough to support inflation “returning to the committee’s symmetric 2% objective” rather than merely “near” the objective. We take the admittedly modest language change as an affirmation of how dovish rates policy will be going forward and as down payment on the changes looming in the June policy framework review.
** Likewise, the reference to household spending – the key linchpin to the current above trend growth – in the descriptive first paragraph of the statement was downgraded from “strong” to rising at a “moderate” pace. Powell also noted in his opening press remarks that “business investment and exports remain weak and manufacturing output has declined over the past year.” With a mention of the coronavirus risks tossed in during the presser for good measure, it translates into an FOMC that is going to be highly reluctant to even talk about a tightening in the policy stance any time soon.
** And on the balance sheet policy, Chairman Powell went to great, careful lengths to map out the Fed’s strategy to avoid a repeat of the September repo spike or the 2013 taper tantrum in a push towards reaching an ample reserves level. But in probing for the eventual level of ample reserves, the Fed is most certainly not on a pre-set course: ”We’re prepared to adjust the details of this plan, as we’ve shown ourselves willing to do depending on conditions.”
** “Ample reserves” is for now defined with a floor, of $1.5 trillion, in bank reserves the FOMC deems as the minimal level of excess reserves needed to ensure the smooth operation of monetary policy through the fluctuations in non-reserve liabilities, mostly the Treasury General Account. The eventual total for a steady balance sheet size will be determined in the second quarter this year.
** Powell confirmed the Fed will taper the pace of their $60 billion a month in bill purchases once they get a better feel for the optimal level of reserves in the second quarter, essentially when they will be able to monitor the fluctuations in the Treasury General Account during the April tax season. ”We intend to slow the pace of purchases and transition to a program of smaller reserve management purchases that maintains an ample level of reserves without the active use of repos.”
** The current repurchase agreement operations will also start to be wound down as the level of bill purchases brings the central bank closer to its ample reserves objectives. “Over the first half of this year, we intend to adjust the size and pricing of repo pricing as we transition away from active use in supplying reserves.”
** Chairman Powell was also very careful to gently push back on the market’s lust to trade the balance sheet expansion as a QE push to higher asset prices: “Many things can affect markets,” he noted. “But what I can tell you is our intention” to wind down the asset purchases and repo operations once an “ample reserves” level of reserves is reached. He later added that “we do see asset valuations as being somewhat elevated, though he book-ended a list of risk spreads, PE ratios, and leverage the Fed is actively monitoring by noting “valuations are high but not at extremes.”
** And finally, we thought it interesting that Chairman Powell affirmed the FOMC has yet to come to a decision on the proposed Standing Repo Facility, and indicated they are still “several months away” from drawing conclusions on a “cost/benefit to a more active repo role” in the future shape of monetary policy operations once they have achieved its “ample reserves” goal.