What the Fed minutes didn't say is what matters

By John Authers

Few writers make as concerted an effort to be as dull as possible as the scribes at the Federal Reserve who pull together the published minutes of the central bank’s monetary policy meetings. In general, the minutes are extremely uninteresting. But that’s because they are meant to be uninteresting. The entire point of Fed communications (with a few very rare exceptions) is to do as little as possible to surprise and excite markets.

At first sight, the minutes released Wednesday from the Sept. 25-26 meeting at which the Federal Open Market Committee agreed to raise their target for the federal funds rate by an additional quarter of a percentage point and continue with its established policy of quantitative tightening, or reducing its balance sheets assets, were a good case in point. A first, second and third reading revealed nothing that could qualify even as a minor as a “surprise” for a journalist desperate for a news story.


But I failed to accounted for fixed-income traders anxious for an excuse to make a trade. And it is also, as always, important to look at what was not in the minutes as what was in the minutes. A sudden rise of 5 basis points in the benchmark 10-year Treasury note yield to just above 3.20 percent implies that something important happened – or that somebody somewhere really wanted an excuse to sell some bonds. It also helped push the Bloomberg Dollar Spot Index back toward the top of its recent range.

It is likely that many were uncomfortable holding bonds after they had recovered somewhat in the last week from a selloff that started in late August and lasted until early October. The lack of any dovish surprises (suggesting that the Fed would be more lenient than previously thought) may well been just enough to trigger the selling. That gives us one example where what goes unsaid is more important than what is said..

If we go by the best approximation for the market view of likely future interest rates available to us, which is Bloomberg’s World Interest Rate Probability, or “WIRP,” function, then it is clear that the market does not expect much more tightening from the Fed. If we assume that one more rate rise is left this year, in December, then fed funds futures suggest that the chances of two rates increases next year, bringing the fed funds rate to a range of 3.0 percent to 3.25 percent, are barely above 60 percent. The odds of three rate rises is only one in four. These probabilities have risen somewhat in the last few months, but not by all that much:

This is strange because the forecasts from September’s meeting showed that nine of the 16 Fed governors and regional presidents who vote on monetary policy expect at least three rate hikes next year, with five of them expecting even more. The market is clearly behind the Fed, and sees some reason for the central bank stop hiking relatively soon, but it is not clear why the market thinks that way.

The most interesting section of the minutes covered the issue of when the Fed should stop the hiking process and whether it should continue until rates are considered restrictive in that they restrain the economy, or stop when they are still neutral. But this is only interesting compared with the rest of the document. This section still leaves all options open:

Participants offered their views about how much additional policy firming would likely be required for the Committee to sustainably achieve its objectives of maximum employment and 2 percent inflation. A few participants expected that policy would need to become modestly restrictive for a time and a number judged that it would be necessary to temporarily raise the federal funds rate above their assessments of its longer-run level in order to reduce the risk of a sustained overshooting of the Committee's 2 percent inflation objective or the risk posed by significant financial imbalances. A couple of participants indicated that they would not favor adopting a restrictive policy stance in the absence of clear signs of an overheating economy and rising inflation.

It is worth pointing to one other area in which the Fed chose to say nothing. One of the strongest reasons for the Fed to desist from raising rates is because it may cause the dollar to appreciate further. A stronger dollar potentially makes life harder for US exporters, just as the Trump administration has made aggressive trade policy a priority. It also makes life far harder for policy makers in emerging markets. A strong dollar and higher US rates tend to spark a rush of money flowing out of emerging markets – a phenomenon that has been witnessed several times in the last two decades.

In September 2015, the Fed and then Chair Janet Yellen decided not to raise rates, as emerging markets had recently suffered severe turbulence following a surprise currency devaluation by China. The hiking cycle did not start until December of that year, when markets had calmed down somewhat. Jay Powell, Yellen’s successor, has made it clear that he thinks the impact of US monetary policy on the rest of the world is overstated. It is fair to infer that he is less likely than Yellen to defer from raising rates because of concerns over emerging markets.

This is the relevant section of the minutes on the current difficulties facing emerging markets, which include true crisis conditions in Turkey and Argentina:

Global financial markets were volatile during the inter-meeting period amid significant stress in some EMEs, ongoing focus on Brexit and on fiscal policy in Italy, and continued trade tensions. On balance, the dollar was little changed against AFE currencies and appreciated against EME currencies, as financial pressures on some EMEs weighed on broader risk sentiment. Turkey and Argentina experienced significant stress, and other countries with similar macroeconomic vulnerabilities also came under pressure. There were small outflows from dedicated emerging market funds, and EME sovereign bond spreads widened. Trade tensions weighed on foreign equity prices, as the United States continued its trade negotiations with Canada and placed additional tariffs on Chinese products.

The emphasis on financial pressures is mine. Many – myself included - would say that those financial pressures were in large part created by US monetary policy. What was not said, I suspect, tells us a lot about the Fed’s intentions.

Much can happen to divert the Fed from its stated path, but it looks likely to me that the Fed will boost the federal funds rate a full percentage point higher than it is now by the end of next year. Every time the Fed chooses not to douse down the possibility, we can expect US bond yields to rise. And the effect on emerging markets will be very interesting.