Fed is tightening in a gradual way – BMO CM

Michael Gregory, Deputy Chief Economist at BMO Capital Markets explains that the latest release of the Minutes from the May 2-3 FOMC meeting proffered some important insights into the June policy confab and beyond and most importantly it suggested that a rate hike on June 14th is still on schedule.

Key Quotes

“We suspect policymakers have seen nearly enough evidence, allowing for the impact of weird wet April weather, with another decent employment report and some signs May data are drying off serving the required remainder of evidence.”

“The FOMC is not too bothered by core inflation’s cooldown, so no need to slow the quarterly tightening clip down. “Most participants viewed the recent softer inflation data as primarily reflecting transitory factors” and, in the case of March’s readings (which we’ve mentioned before), owing to “quality-adjusted prices for wireless telephone services.”

“The FOMC is also not too bothered by the low jobless rate (which is matching the lowest level in 16 years), so no need to pick up the tightening pace either. “Generally, participants continued to expect that if economic growth stayed moderate, as they projected, the unemployment rate would remain, for the next few years, below their estimates of its longer-run normal level.”

“The policy-postponing potential of “global economic and financial developments” appears to be less of an issue than in the past (recall 2013’s taper tantrum, 2015’s liftoff delay until December and 2016’s four-rate-hike plan ending up as only one). This makes it easier for the FOMC to stick to the median rate-hike projection (three hikes this year). “Many participants saw the risks stemming from global economic and financial developments as having receded further over the intermeeting period. They pointed to the encouraging tone of recent data on economic growth abroad, which suggested some upside risks to foreign economic activity.”

“And, the start of balance sheet normalization is approaching. “Nearly all policymakers expressed a favorable view of this general approach.” And what was the approach? Set a dollar cap and reinvest only principal payments above the cap. The cap would be set low at first (they didn’t say how low but a $5-to-$10 billion monthly cap for both Treasuries and MBS appears appropriate to start). The cap would be raised every three months (say, e.g., by at least another $5-to-$10 billion), and the entire tapering-reinvestments plan would be preannounced.”

“The Minutes went on to say: “Nearly all policymakers indicated that as long as the economy and the path of the federal funds rate evolved as currently expected, it likely would be appropriate to begin reducing the Federal Reserve’s securities holdings this year.”

“Bottom line: The FOMC appears to be keeping to a quarterly tightening tempo, one that is proving to be increasingly impervious to temporary bouts of data misbehaving, and one that will likely be interrupted in December with the start of reinvestment tapering.”