Fed Watcher’s Guide to Minutes: Exit Strategy, Employment View

Here’s what to look for when the Federal Reserve releases minutes from the Federal Open Market Committee’s April 29-30 meeting at 2 p.m. in Washington.

-- Exit strategy: The minutes may show that Fed Board members discussed possible changes to the central bank’s strategy to exit from record stimulus, according to Bank of America Corp. economists led by Ethan Harris, co-head of global economics research. The strategy lays out the sequence of steps for shrinking the balance sheet and raising interest rates.

-- “If we do get comments around the exit strategy, we would expect the Fed to reiterate that it is likely to hold most of its assets to maturity rather than sell,” Harris said in a research note. The central bank may also indicate it will start raising the main rate around the time it ends reinvestment of maturing assets on the balance sheet or soon after, he said. The Fed is currently buying $45 billion in bonds each month to hold down long-term interest rates.

-- It’s unclear whether the discussion “will be only a step forward in the brainstorming process or whether they’ll come to a conclusion” on changes to the strategy, said Thomas Costerg, a New York-based economist at Standard Chartered Plc. Fed Chair Janet Yellen may want to wait for board nominees Stanley Fischer, Lael Brainard and Jerome Powell to win confirmation in the U.S. Senate, he said. The Senate is set to vote on Fischer’s nomination today.

-- Main rate path: FOMC policy makers may signal their preferences for changes in the way they communicate the path for the main interest rate, Thomas Simons, a government-debt economist in New York at the primary dealer Jefferies Group LLC, said in an interview.

Inflation Outlook

-- The current guidance is “not something that they see as 100 percent optimal,” Simons said. “It’s very likely it’s going to evolve.”

-- In March, the Fed dropped a pledge to keep the benchmark federal funds rate low at least as long as unemployment was above 6.5 percent and the outlook for inflation didn’t exceed 2.5 percent. The Fed acted after unemployment dropped to 6.7 percent, even as other labor-market gauges showed continued weakness. The FOMC instead said it will look to a “wide range” of information to determine when to begin raising the fed funds rate. The Fed has held the rate close to zero since December 2008.

-- Also in March, officials released projections showing the rate rising faster than they previously estimated, pushing up bond yields. The Fed shows the projections as dots on a chart, with each dot representing an unidentified official.

‘Dot Plot’

-- The minutes may show concern about “the potentially unintended (and undesired) signaling effect from changes” in the forecasts, said Carl Riccadonna, senior U.S. economist for Deutsche Bank Securities in New York. “The fact that policy makers were fretting the market’s interpretation of a slightly more hawkish ‘dot plot’ signifies that the committee continues to have a clear dovish inclination,” he said in a note to clients.

-- Labor market slack: The minutes may show disagreement over how close the Fed has come to achieving full employment, said Gennadiy Goldberg, a U.S. strategist at TD Securities USA LLC in New York. Fed officials saw maximum unemployment ranging from 5.2 percent to 5.6 percent, according to their March projections. The rate was 6.3 percent in April.

-- “Depending on everyone’s opinion, the labor market is very good or very bad,” Goldberg said. “Some of the hawkish members might view the natural rate of unemployment as very close” while officials favoring accommodation may disagree.

Excess Liquidity

-- Toolkit for tightening: Fed officials probably discussed ways to tie up excess liquidity when the time comes to raise interest rates, according to Michelle Girard, chief U.S. economist at RBS Securities Inc. in Stamford, Connecticut.

-- The Fed since September has experimented with an overnight, fixed-rate reverse-repurchase program to remove cash from the banking system. In a reverse repo, the central bank lends securities for cash for a set period. At maturity, the securities are returned to the Fed, and the cash to its counterparties.

-- Federal Reserve Bank of New York President William C. Dudley yesterday said the program will probably help set a floor under money-market rates and “would tend to make financial instability less likely.” Still, during a financial crisis, investors may flee into the repo program from riskier assets, further pushing down valuations and intensifying the turmoil, he said in a speech.

-- Excessive risk: While Yellen has said she doesn’t see the emergence of asset price bubbles, FOMC participants may want to pull back accommodation earlier should they see an unwarranted rise in valuations, Riccadonna said.

-- “This will be a critical theme to watch for in future Fed deliberations, particularly if interest rates fall further or stocks register new highs,” he said. “Heightened asset bubble concerns could introduce a ‘third variable’” into the Fed’s plans for the path of the main interest rate, along with progress on its goals for full employment and stable prices.

Before it's here, it's on the Bloomberg Terminal.