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FOMC Minutes to Reinforce ‘Patient’ Mode; May Offer Clues on Balance Sheet Reduction

The minutes of the Federal Reserve’s January policy meeting are due to be published on Wednesday at 19:00 GMT and will be inspected for confirmation that the world’s most important central bank is on hold for the foreseeable future. However, since January, policymakers, including Chairman Jerome Powell, have been pretty consistent in signaling that the Fed is in wait-and-see mode, hence, the focus of the minutes will be on possible changes to the balance sheet reduction plan. Although the Fed’s dovish pivot has already been priced into the US dollar, clearer hints of an early end to shrinking the balance sheet could lift stock markets, while weighing on Treasury yields and the greenback.

Powell took markets by surprise on January 4 when he first indicated that the Fed “will be patient as we watch to see how the economy evolves”. After all, only three months earlier, Powell had said the Fed was a “long way” from neutral interest rates. While political pressure from the White House may have contributed to the dramatic shift, the main reason for the Fed’s change of tune was the significant tightening of financial conditions, led by hefty declines in US and global equities towards the end of 2018.

At the policy meeting on January 29-30, the Fed surprised again by seemingly appearing to rule out further rate hikes in 2019. But the Fed’s U-turn didn’t stop there and signaled its readiness to adjust its balance sheet normalisation plan “if future economic conditions were to warrant a more accommodative monetary policy”. That balance sheet reduction plan, dubbed as quantitative tightening, will likely be the focal point of Wednesday’s minutes as investors will want to see just how far the discussions of such a move have advanced.

Many analysts see the Fed’s balance sheet roll-off, which has been on auto-pilot since October 2017, as adding to the market stress by raising long-term borrowing costs. Although the Fed has refused to take the blame for the recent market turmoil, speculation has been growing that the central bank will soon announce an early exit from its plan to shrink the balance sheet. Fed Board Governor Lael Brainard gave the strongest indication yet of this last Thursday by saying that the “balance sheet normalization process should probably come to an end later this year”.

Any signs from the minutes that a decision could arrive as early as the next meeting on March 19-20 would likely fuel the rebound in equities markets, while pressuring the US currency. The March meeting is also when Federal Open Market Committee (FOMC) members will be updating their quarterly economic projections, including the dot plot chart, making a major announcement then more probable.

If there’s evidence in the minutes that FOMC members are planning on maintaining a larger post-QE balance sheet than previously envisioned, dollar/yen could initially seek support at the 50-day moving average (MA) just above the 110 handle. A slip below this level could accelerate the decline towards the 50% Fibonacci retracement of the upleg from 104.55 to 114.54 at 109.55.

However, if the Fed signals that changes to its balance sheet unwinding plan are still some time away, dollar/yen could clear the immediate hurdle around the 38.2% Fibonacci at 110.73 and aim for the 200-day MA at 111.30. However, chances of stronger gains from the minutes alone and a move towards the 23.6% Fibonacci at 112.18 are remote as the Fed is unlikely to stray from its recent dovish stance.

Moving beyond the January minutes, the March gathering is already looking like it’s going to be another crucial policy meeting as markets will get the first real glimpse of policymakers’ outlook on GDP growth, inflation and the projected path of the fed funds rate following the dovish shift. With some market participants holding the view that the Fed has leaned too far towards the dovish end of the spectrum, there will be a lot of attention on whether FOMC members will retain at least one rate hike in their forecasts or abandon further tightening altogether for 2019. If the Fed does not keep its options open, there is a risk Powell may need to perform another U-turn later in the year if the US economy does not slow as much as currently being feared and the trade war-related risks dissipate.

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