Economy: More Waffle At The Fed

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07/06/2017 | 09:02 am
Would you like eggs with your waffle, Janet? Courtesy of the FOMC members who remain "chicken", despite a strengthening U.S. economy.

The minutes from the June FOMC meeting revealed a divided Federal Reserve policy committee which couldn’t reach an agreement on the timing of when to begin shrinking the Fed’s massive balance sheet.  According to the minutes, “several (members) preferred to announce a start to the process within a couple of months….some others emphasized that deferring the decision until later in the year would permit additional time to assess the outlook for economic activity and inflation.”

It sure looks like the markets will have to endure another period of speculation over when the Fed will begin moving. Just like markets endured as the Fed waffled in scaling back prior extraordinary measures. Remember the QE “taper tantrum” in 2013, the initial discussion of a rate hike in 2014, the long hesitation before the first rate hike in December 2016, and finally another full year of hesitation before the FOMC enacted a second rate hike?  Well, the saga is likely to continue, this time surrounding the shrinking of the Fed’s balance sheet.

The Fed said in June it would runoff maturing principal payments on Treasuries initially at $6 billion per month, increasing by $6 billion every three months over 12 months, until it reaches $30 billion per month.  For agency and mortgage-backed securities debt, the cap starts at $4 billion, and rises by $4 billion every three months until it hits a $20 billion a month.  However when enough FOMC committee members agree on a start date will be a subject of debate in financial markets for many months to come.  And even after balance sheet reduction begins, the rate at which the Fed allows its bond holdings to runoff will likely end up being debated each time we get a bad macroeconomic data point or when the Dow Jones Industrial Average slips -3%.  And many market observers are unclear now on what signs the Fed is looking for to pace their balance sheet reduction: inflation, unemployment, economic activity, or the S&P 500 (SPY) performance?

The upside for equity investors is that the Federal Reserve (along with the European Central Bank and the Bank of Japan) will remain intractably involved in financial markets for the foreseeable future.  And it’s difficult to foresee any kind of meaningful equity correction – and much less a bear market – with central banks serving up an indefinitely long period of excess liquidity and low rates.  Gluttonous equity investors can add some whipped cream to this Fed waffle.

Owen Williams
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