Precious Metals talking points 040722: Key points and background from the Fed Minutes

By: Rhona O'Connell, Head of Market Analysis

Thu, 07 Apr 2022, 08:45

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Key points and background from the Fed Minutes

Rhona O'Connell

Head of Market Analysis, EMEA & Asia;

+44 203 580 6115; mobile +44 7384 833 297

rhona.oconnell@stonex.com

Key points: -

These five points are the essential ones to note. More details are below and are essentially extracts from the Minutes, with no additional comment [beyond the fact that there was, perhaps understandably, no indication as to the rate of run-off. Fed Balance sheet currently at $8.94Tn. The recent low was $3.77Tn, on 11^th September 2019 so the expansion since then was 5.2% (138%), roughly equivalent to Japan’s GDP].

No decision taken wrt the Committee’s plan to reduce the balance sheet, but it was agreed that substantial progress had been made and that the Committee was well placed to begin the process of reducing the balance sheet as early as after the conclusion of the May meeting
Demand for labour exceeds supply, many businesses struggling with hiring and retention. Nominal wages thus rising at fastest pace in many years, and strongest in the lower quartile, but starting to spread across the income and skill distribution
Inflation broadening from goods into services, especially rents. In some areas wage and input costs are being passed through to consumer prices without any notable increase in demand.
Many participants would have preferred a 50-point hike in March but accepted that the Ukraine position justified holding it to 25
Move to a neutral monetary policy “expeditiously” would be appropriate and, subject to future economic and financial development, a tightening could be warranted.
Action: a 25-basis point hike in March, potential to start tightening as soon as May. Only dissenting vote; James Bullard.

Background

Russian invasion of Ukraine: -

rouble down 40% vs $.
$-denominated Russian bonds down 80-90%
Global financial conditions tightened; declines in equity prices, rises in sovereign yields and credit spreads, $ appreciation
Options prices suggest that despite the recent correction, there is a high probability that prices will remain high in coming months
Near-term inflation threats increased sharply in some advanced economies
Liquidity strains in some markets, but high banking reserves added some stability

Despite geopolitical uncertainty “many central banks” continued to signal intention to tighten in order to address inflation

Market-implied 1Y forward rates rose notably.

In the States: -

market rates implied expectations of a 25-point hike at the March meeting, while futures prices implied a 170-point rise through year-end, ~70 points higher than what was priced in at the time of the January meeting.
Median projection from most recent surveys of primary dealers and market participants showed expectations of a 150 point rise in the target range for fed funds by year end, a further 100 basis point rise by H1 2024 and then down to the longer-run level in 2025

Plans for run-off

Staff presented a range of options for a run-off in a predictable manner

All options featured more rapid run off than in 2017-19.

Use of SOMA (open market operations for securities including FX).

Learning from the previous run-off; agreement that it would be appropriate to first slow and then stop the decline in the size of the balance sheet when reserve balances were above the level consistent with “ample reserves”. Close monitoring of money market conditions and indicators of near-ample reserves will be necessary.

No decision taken wrt the Committee’s plan to reduce the balance sheet, but it was agreed that substantial progress had been made and that the Committee was well placed to begin the process of reducing the balance sheet as early as after the conclusion of the May meeting

Economic Situation

Q1 GDP rising at slower rate than previous quarter. PCE remained elevated at 6.1% for 12M to January; core was 5.2%. Staff’s common inflation expectations index largely levelled off and was close to its 2014 average.

Strong NFPR growth Jan Feb

Pirate sector job openings (JOLTS) little changed from November and well above pre-pandemic levels.

Average hourly earnings +5.1% in 12M to February.

Housing strong but still plagued by shortages.

Motor vehicle production declined sharply- supply constraints, chips and other.

Other manufacturing improving, but bottlenecks still in place, especially electronics and aluminium.

Transportation and distribution still held back by port congestion and shortage of truck drivers.

Financial Situation

Investors interpreted economic data and Fed communications as implying a more rapid removal of monetary policy that previously expected.

TIPS’ implications rose sharply basis CPI and the invasion.

Strained liquidity generating volatility and may have contributed to particularly large swings in Treasury yields.

Households; credit remained accommodative. Credit card balances increased significantly in Q4; auto credit grew at a moderate pace.

Corporate credit ratings improving on balance.

Some stress in the commercial real estate sector.

Outlook

Staff expected GDP to step down markedly from 2021 and then pick up slightly in 2023

Participants noted that Omicron left only a mild and brief imprint on economic data. GPD growth projections revised downward from the December forecasts, reflecting reduced inventory investment from the strong pace of 2021, reduced fiscal and monetary policy and the invasion.

Noted that demand for labour exceeds supply, many businesses struggling with hiring and retention. Nominal wages thus rising at fastest pace in many years; strongest in the lower quartile, but starting to spread across the income and skill distribution.

Inflation broadening from goods into services, especially rents. In some areas wage and input costs are being passed through to consumer prices without any notable increase in demand.

Some near-term consumer inflation expectations have become more sensitive to actual inflation readings since the start of the pandemic. Longer-term expectations appear to remain well-anchored.

Outlook risks

Elevated uncertainty over inflation – supply bottlenecks, rising energy and commodity prices. Downside risks would include broad tightening in financial conditions and a prolonged rise in energy prices.

Monetary policy stance: -

US economy very strong

Extremely tight labour market

Inflation well above the 2% target: -

Agreed to raise fed funds target at the March meeting

Appropriate to begin run-off soon, “possibly as soon as in May”

Many participants would have preferred a 50-point hike in March but concurred that the Ukraine position justified holding it to 25.

Many noted that 50 points could be appropriate in future, particularly if inflation pressures remained elevated or intensified.

Move to a neutral monetary policy “expeditiously” would be appropriate and, subject to future economic and financial development, a tightening could be warranted. But, especially with the Ukraine backdrop, risk management remains key.

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