In the minutes for the January FOMC meeting, the members elaborated the rationale for their dovish shift. While affirming solid growth and the resilient employment market, the members focused on the softening inflation and were concerned about the “muted” price pressure. Together with rising uncertainty from aboard, including rapid deceleration in the economies of China and the Eurozone, and Brexit, the Fed judged that it would be more prudent not to signal when, and what, the next “adjustment” in the monetary policy would be. Meanwhile, the Fed also indicated that a plan to end the balance sheet reduction would be announced in coming meetings.
As astonishing point at the post meeting statement was the removal of the forward guidance which suggested “some further gradual increases in”. Instead, the Fed called for “patience” in deciding “future adjustments” to the policy rate. As elaborated in the minutes, the members “supported a patient approach to monetary policy at this juncture as an appropriate step in managing various risks and uncertainties in the outlook”. They judged that such approach gives them “an opportunity to judge the response of economic activity and inflation to the recent steps taken to normalize the stance of monetary policy” and allows “time for a clearer picture of the international trade policy situation and the state of the global economy to emerge”. The minutes also suggested that “many” members remained unclear about “what adjustments to the target range for the federal funds rate may be appropriate later this year”. Yet, they believed that the “patient” language could be replaced by others if “uncertainty abated”. This reveals that the Committee has not even a consensus of whether the next move would go “up” or “down”. Meanwhile, it appears that, going forward, the Fed’s forward guidance would also be data-dependent.
Fed’s indication in January that it is “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments” was interpreted as very dovish. Many have since then forecast it would end the balance sheet reduction program very soon. In the minutes, the Fed noted that “almost all participants thought that it would be desirable to announce before too long a plan to stop reducing the Federal Reserve’s asset holdings later this year”. We expect the Fed would announce its plan in as soon as the March meeting. Recall that the Fed began unwinding the assets (mainly Treasury bonds and mortgage-based securities), worth of about US$ 4.5 trillion, it purchased during QE in October 2017. As former FOMC chair Janet Yellen announced the plan, she did not signal the ideal size of the reduction. If things go according to schedule, the Fed should have trimmed the size by about US$ 1 trillion, shrinking the balance sheet to about US$ 3.5 trillion. This should still be compliant with the desire of “a substantial majority” of participants that “when asset redemption ended, the level of reserves would likely be somewhat larger than necessary for efficient and effective implementation of monetary policy”.
While the Fed appears undetermined about when, and what, the next move would be, we believe that the chance is higher for a hike than a cut, given the economic growth remains solid and the unemployment rate stays far below the long-term target. Yet, the timing of the move really depends on the inflation outlook.