Thread by @VaradMarkets

#FOMC Hawkish Minutes: #Fed Balance Sheet BS

Five topics discussed:
1⃣ Preferred tool for policy normalization: Rate hike v/s BS reduction
2⃣ Comparison with 2014 normalization
3⃣ Timing & sequencing of tools
4⃣ Size & composition of Long Run BS
5⃣ Yield Curve shape

1/12

Note: Quantitative Tightening = BS reduction whereas 'Tapering' is reducing pace of BS expansion (currently underway)

1⃣ Rate Hike v/s QT:
“Participants..emphasized..federal funds [FF] rate should be Committee's primary means for adjusting stance of monetary policy”

Why?

2/12

[A] FF rate more familiar tool to general public => [better] for communication

[B] FF gives policy buffer - easier to adjust FF rate in emergency - “few participants..noted..Committee could more nimbly change interest rate than BS in response to economic conditions”

3/12

2⃣ FOMC’s judgment of current situation (v/s 2014, previous normalization):

▪️ Economic outlook much stronger
▪️ Inflation higher
▪️ Labour market tighter
▪️ BS much larger, dollar terms & as % of GDP
▪️ BS weighted average maturity shorter

4/12

▪️ Now better positioned for BS normalization - why?
- Ample reserves
- rate control => interest on reserve balances
- ON Reverse Repo RRP facility
- Standing Repo Facility SRF

“Some observed…BS could potentially shrink faster than last time”

5/12

“Several…raised concerns about vulnerabilities in Tsy mkt => could affect..pace of BS normalization”

“Some..judged..significant BS shrinkage could be appropriate over normalization process…[given] abundant liquidity in money mkts & elevated usage of ON RRP facility”

6/12

3⃣ Timing of BS run-off:
Previous experience - BS runoff started ~2 yrs after policy rate liftoff

"appropriate timing of BS runoff..likely be closer to that of policy rate liftoff than in previous experience"

"decision to initiate runoff would be data dependent"

7/12

Size of Long-Run BS:
"noted..current [BS] size elevated & would likely remain so for some time after BS normalizing was under way"

"important to carefully monitor developments in money markets to [assess] appropriate level for Long run BS as the level of reserves fell"

8/12

"several..[noted]..establishment of SRF could reduce demand for reserves in longer run => longer-run BS could be smaller than otherwise"

4⃣ Composition of BS
"some..preference for Fed's asset holdings to consist primarily of Tsy securities [v/s Agency MBS] in longer run"

9/12

5⃣ Yield Curve Shape
“Some...[BS run off better than rate hike to]..help limit yield curve flattening during policy normalization”

“few..raised concerns..relatively flat yield curve could adversely affect interest margins for some fin intermediaries=> fin stability risks”

10/12

Yield curves currently significantly flatter v/s last year with collapse in Term Premium

UST 2x10 at +87 bp v/s +158 bp recent peak in Mar'21
UST 5x30 at +66bp v/s +163 bp Mar'21 peak

11/12

https://twitter.com/VaradMarkets/status/1422832084507250691?s=20

Overall, Fed wants to get on with Tapering, Rate Hike & QT asap. Only constraint: do not tighten financial conditions too much (read as Equity & Equity Vol)

If equities recover, look forward to hawkish Jan FOMC, though mkts may have already priced enough hawkishness by then