Investors closely watched the FOMC Minutes. The language used by the Fed is essential to build up future expectations about the monetary policy and, thus, adjust investing.
Yesterday’s FOMC Minutes release revealed what the discussions were three weeks ago when the FOMC (Federal Open Market Committee) last met. As expected, they showed an overall hawkish picture, but some exciting nuances appeared.
Here are four points to keep in mind regarding yesterday’s FOMC Minutes release:
- The economy and labor market remain robust
- All members are in favor of 50bp rate hikes next
- Quantitative Tightening begins June 1st
- Fed wants to reach the neutral interest rate
A strong economy and labor market
Fed members acknowledged that the labor market has added a substantial number of jobs lately. Moreover, the unemployment rate declined as well, pointing to tight labor market conditions warranting further tightening.
Coupled with other economic data at hand, Fed members concluded that the economy is robust, so the tightening of financial conditions is appropriate.
All members favor 50bp rate hikes in June and July
The Fed already delivered one 50bp rate hike in May, but all members are now in favor of doing something similar at the next two meetings. As such, after the end of the July meeting, the federal funds rate is expected to be one full percentage higher.
Quantitative Tightening begins at the start of June
In recessionary times, such as during the COVID-19 pandemic, central banks engage in Quantitative Easing – a process where the central bank buys government debt. Now that the recession is over and the economy sees robust gains, the Fed plans to reverse that process.
As such, Quantitative Tightening is scheduled to begin in June 1st. Just as Quantitative Easing helped ease the monetary policy, Quantitative Tightening will help tighten financial conditions.
However, there’s a catch. It has never been done before at such a large scale.
Fed is on its way to reaching the neutral interest rate
An economy’s neutral rate is made of the average long-term growth rate and the inflation rate. It cannot be observed directly, so it is rather estimated.
Nevertheless, while the interest rate is below the neutral rate, the policy is accommodative. Thus, the Fed wants to reach a neutral stance as quickly as possible, to remove any accommodation conditions from the economy.
So what does all mean for stocks?
The Fed said nothing new in yesterday’s release. But there is one big unknown that the markets have not witnessed yet at full scale – the Quantitative Tightening program that begins a few days from now.
Until the market has a clear picture of what it means and what its effects are, uncertainty will prevail.