The Federal Reserve’s (Fed) policy-making arm, the Federal Open Market Committee (FOMC), released the minutes from its March 14-15, 2017 meeting yesterday and there were many highlights, but two themes stood out that spooked the markets. First, the minutes stated that participants were beginning to discuss the gradual reduction of the Fed’s $4.5 trillion balance sheet. The second theme, although not explicit in the minutes, centered on language that indicated some Fed participants are concerned that equity valuations are relatively high, and that a correction is possible.
As is often the case, the initial reaction to the minutes may have been overdone. Intraday gains in the stock market quickly evaporated; however, the equity futures market recovered overnight, and stocks opened higher in today’s session. Here are some highlights from the minutes and market reactions:
- Equity markets: The equity markets reacted negatively to comments that some Fed officials “viewed equity prices as quite high relative to standard valuation measures.” Many officials noted that “recent and prospective changes in financial conditions posed upside risks” to forecasts, and “downside risk if there were a significant correction in financial market.” Fed officials’ emphasis that “they stood ready to change their assessments of, and communications about, the appropriate path for the federal funds rate in response to unanticipated developments,” has the markets on edge.
- Treasury market: Treasury yields were higher following the news, but as is often the case, the initial move may have been overdone. The 10-year Treasury yield recovered later in the day, closing just one basis point higher at 2.36%, while equity futures were trending higher heading into Thursday’s session.
- S. economy: Regarding the economy, most Fed officials agreed that the data were mostly in line with expectations for the period February 1 to March 15, 2017. They noted that “their views of the economic outlook were essentially unchanged” from past meetings and almost all data were consistent with the recent interest rate hike. This message continues to support the Fed’s confidence in the U.S. economy.
- Monetary policy: Discussion centered on a potential policy change that would begin to shrink the Fed’s $4.5 trillion balance sheet later in 2017. No decision was made; however, the minutes clearly state that policymakers are moving in this direction and have agreed to reaffirm the Committee’s Policy Normalization Principles and Plans. This has the potential to reduce the number of rate hikes this year as the Fed would prefer not to increase volatility by aggressively raising rates while at the same time normalizing the balance sheet.
- Interest rate hikes. Fed officials reaffirmed that a “gradual pace” of interest rate increases is likely to be appropriate and they continue to look for two more rate hikes in 2017, although New York Federal Reserve President William Dudley said on Friday that “if we start to normalize the balance sheet, that’s a substitute for short-term rate hikes,” and “we might actually decide at the same time to take a little pause in terms of raising short- term rates.” We continue to expect two additional rate hikes for 2017 (three for the full year).
Please stay tuned to the LPL Research blog for our continued coverage of the Federal Reserve.
The economic forecasts set forth in the presentation may not develop as predicted.
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The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve Board that determines the direction of monetary policy. The eleven-person FOMC is composed of the seven-member board of governors, and the five Federal Reserve Bank presidents. The president of the Federal Reserve Bank of New York serves continuously, while the presidents of the other regional Federal Reserve Banks rotate their service in one-year terms.
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