The following represents only a portion of the full list of newswire headlines associated with today’s Fed Minutes release, but these are likely the most responsible for the market movement. Each will be followed with a brief translation into more tangible language.
MANY PARTICIPANTS NOTED THAT THE PANDEMIC, PARTICULARLY NEW VARIANTS OF THE VIRUS, CONTINUED TO POSE DOWNSIDE RISKS TO ECONOMIC ACTIVITY AND UPSIDE RISKS TO INFLATION
I’m including this one just as a reminder that the Fed is aware of Omicron and they continue to view it as an unknown that could change their outlook. But the point is that the meeting took place 2 weeks after the emergence of omicron, so we can’t really assume that what follows is “stale thinking” from the Fed.
POLICYMAKERS AT DECEMBER MEETING BEGAN DISCUSSION OF EVENTUAL NORMALIZATION OF MONETARY POLICY, INCLUDING APPROACHES FOR REMOVING ACCOMMODATION, AND SIZE, COMPOSITION OF BALANCE SHEET
This just sets the stage for the rest of the bullet points. It means they’re discussing decreasing the size of the balance sheet by foregoing reinvestments of bond portfolio proceeds. Run-off = normalization = balance sheet reduction
SOME PARTICIPANTS ALSO NOTED THAT IT COULD BE APPROPRIATE TO BEGIN TO REDUCE THE SIZE OF THE FEDERAL RESERVE’S BALANCE SHEET RELATIVELY SOON AFTER BEGINNING TO RAISE THE FEDERAL FUNDS RATE
Some Fed members think the Fed should start letting bonds roll off the balance sheet rather than reinvesting, and that the process should begin shortly after they start hiking rates.
MANY POLICYMAKERS JUDGED APPROPRIATE PACE OF BALANCE SHEET RUNOFF WOULD LIKELY BE FASTER THIS TIME THAN LAST
Pretty self explanatory. Faster shrinkage = worse for bonds
SOME POLICYMAKERS THOUGHT ‘SIGNIFICANT’ BALANCE SHEET SHRINKAGE COULD BE APPROPRIATE IN NORMALIZATION PROCESS
Same story. Bigger shrinkage = worse for bonds.
PARTICIPANTS JUDGED THAT BALANCE SHEET RUNOFF COULD START SOONER AFTER POLICY RATE LIFTOFF THAN LAST TIME
Same story. Earlier shrinkage = worse for bonds.
ALMOST ALL POLICYMAKERS THOUGHT LIKELY APPROPRIATE TO START BALANCE SHEET RUNOFF AT SOME POINT AFTER FIRST INTEREST RATE HIKE
Not as bad as it sounds. This is just their way of laying out a timeline of normalization steps. In other words, once they start hiking rates, that’s when they’ll be considering reducing the balance sheet.
SOME POLICYMAKERS NOTED THAT BALANCE SHEET COULD POTENTIALLY SHRINK FASTER THAN LAST TIME
This sounds like one of the bullet points above, but it was actually a reference to the composition of the portfolio. It has more short term debt in it compared to the last time the Fed needed to normalize. As such, if they adhere to the same policy of ceasing reinvestments, that would imply a faster pace of shrinkage without actually trying to do it faster. Specifically: “Participants noted that the current weighted average maturity of the Federal Reserve’s Treasury holdings was shorter than at the beginning of the previous normalization episode. Some observed that, as a result, depending on the size of any caps put on the pace of runoff, the balance sheet could potentially shrink faster than last time if the Committee followed its previous approach in phasing out the reinvestment of maturing Treasury securities and principal payments on agency MBS.”