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The minutes of the March FOMC meeting got released yesterday, and the Greenback tossed and turned, but ultimately tanked as a result.

What’s up with that?

Well, here are the key takeaways from the meeting minutes that you may wanna know about.

USD Index: 15-Minute Forex Chart
USD Index: 15-Minute Forex Chart

1. Only “gradual” pace of tightening

In my 4 Highlights of the March FOMC Statement, I noted that the Fed’s March projections for the Fed Funds Rate were essentially unchanged from its December projections.

Fed's March Projections

And the minutes of the March meeting affirmed this, since “most participants anticipated that gradual increases in the federal funds rate would continue.” This came with the usual caveats, though, namely that the “economy [continues] to perform about as expected.”

However, Fed officials did emphasize that “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.”

In other words, the Fed could hike at a faster pace or a slower pace as a response to “unanticipated developments.”

And the minutes mentioned the following as examples of “unanticipated developments” that may lead to a faster pace of tightening.

  • the possibility of stronger spending by businesses and households as a result of improved sentiment
  • appreciably more expansionary fiscal policy
  • a more rapid buildup of inflationary pressures than anticipated

The following, meanwhile, may convince the Fed to downgrade their rate hike projections.

  • financial markets were to experience a significant correction
  • potential developments abroad that could have adverse implications for the U.S. economy,” particularly “upcoming elections in EU countries
  • the dollar could appreciate substantially further

2. Why the dissenter dissented (and may keep doing so)

In my 4 Highlights of the March FOMC Statement, I also pointed out that the vote to hike back in March was not unanimous because this guy dissented.

And according to the minutes, Minneapolis Fed President Neel Kashkari didn’t want to vote for a rate hike because in his view, “the recent data had not pointed to further progress on the Committee’s dual objectives.” In addition Kashkari, “preferred that when data do support a removal of monetary policy accommodation, the FOMC first publish a detailed plan to normalize its balance sheet before proceeding with further increases in the federal funds rate.”

I guess that means we can expect Kashkari to keep voting against a rate hike until the Fed comes to a consensus on what to do with its balance sheet, huh?

Speaking of the Fed’s balance sheet…

3. Potential balance sheet policy shift “later this year”

For those who don’t know, the Fed currently has about $4.5 trillion worth of assets in its balance sheet. And the great bulk of those assets happen to be U.S. government bonds and mortgage-backed securities, thanks to the Fed’s QE program.

Source: Q1 2017 Fed Balance Sheet Report
Source: Q1 2017 Fed Balance Sheet Report

And the Fed’s current policy is to maintain its massive balance sheet by reinvesting principal payments, thereby creating artificial demand in the bond market, which depresses bond yields and helps keep long-term borrowing costs low.

However, the minutes revealed that “a change to the Committee’s reinvestment policy would likely be appropriate later this year.”

Fed officials were divided on how to do this, but they “generally preferred” either:

  • an approach that phased out reinvestments, or
  • an approach that ended reinvestments all at once.

According to the minutes, a phased-out approach “was seen as reducing the risks of triggering financial market volatility.” An approach that ends reinvestment immediately, meanwhile, “was generally viewed as easier to communicate while allowing for somewhat swifter normalization of the size of the balance sheet.”

Moving on, Fed officials were also divided on what they would use as a trigger for implementing this balance sheet policy shift. “Several participants” argued that the trigger should be “tied to the target range for the federal funds rate.” In other words, keep hiking to a certain level before implementing the balance sheet policy shift.

Meanwhile, “Some other participants” argued that “the timing should depend on a qualitative judgment about economic and financial conditions.”

In any case, “Nearly all participants agreed that the Committee’s intentions regarding reinvestment policy should be communicated to the public well in advance of an actual change.”

4. Fed officials uncertain about Trump, but…

The Fed thinks that there is “considerable uncertainty about the timing and nature of potential changes to fiscal policies as well as the size of the effects of such changes on economic activity.”

As such, “about half of the participants did not incorporate explicit assumptions about fiscal policy in their projections.” However, “most participants” viewed fiscal stimulus “as an upside risk to their economic forecasts.” Although “some participants” also expressed concern that Trump’s “America First” policies on immigration and trade may be possible “downside risks to labor force and economic growth.”

This raises a question, though. If the other half incorporated fiscal policy into their projections, and most of them think that fiscal policy would be a positive thing, then would that mean that they would downgrade their projections if Trump keeps hitting speed bumps like the recent failure of the healthcare bill?

Thankfully, the minutes revealed that “several participants now anticipated that meaningful fiscal stimulus would likely not begin until 2018.” In other words, Trump’s fiscal policy is not really a major factor in the Fed’s projections (for this year at least).

5. Fed worried about the stock market?

According to the minutes, “Many participants discussed the implications of the rise in equity prices over the past few months.” In addition, “Some participants viewed equity prices as quite high relative to standard valuation measures.”

Moreover, “A few participants attributed the recent equity price appreciation to expectations for corporate tax cuts or to increased risk tolerance among investors rather than to expectations of stronger economic growth.” In simpler terms, “A few participants” think that the U.S. equities rally was fueled by speculation on Trump’s tax plans.

And as mentioned earlier, “a significant correction” in financial markets was listed as one of the downside risks to the Fed’s economic projections.

Final Thoughts

Interestingly enough, the CME Group’s FedWatch Tool shows that odds for a June rate hike actually improved from 62.1% to 66.5% after the minutes got released.

June Rate Hike Odds (As of April 5)
June Rate Hike Odds (As of April 5)

And the likely reason for this is that Yellen said during her February testimonies that the Fed won’t be shrinking the balance sheet until the Fed Funds rate is “high enough to be reduced again in the event of economic turbulence.”

Yellen didn’t define what “high enough” means, but the main takeaway here is that the Fed will very likely continue hiking first before changing their balance sheet policy.

As such, odds for another rate hike got reinforced. And it also explains why the Greenback initially tried to jump higher when the minutes revealed that the Fed may change its balance sheet policy “later this year.”

If that is the case, then why did the Greenback ultimately tank?

Well, the most commonly cited reason by market analysts is that the market was disappointed by the Fed’s affirmation of its “gradual” path of tightening, as well as the market’s realization that a change in Fed’s balance sheet would mean fewer rate hikes in the future.

And as the CME Group’s FedWatch Tool shows, the market is not entirely convinced that the Fed can deliver on two more rate hikes, since odds for two more rate hikes by the December FOMC statement only came in at 55.9%. Although it did admittedly improve from 54% after the meeting minutes got released. By the way, if you’re not familiar with the FedWatch Tool and what it’s all about, you may wanna check out my primer for it here.

December Rate Hike Odds (As of April 5)
December Rate Hike Odds (As of April 5)

There were also other details that may have weighed down on the Greenback, such as Kashkari’s really dovish stance and hints that he may keep voting against a hike.

In addition, the Greenback may have been dragged lower when U.S. equities got sold off in the wake of the FOMC minutes.

After all, some Fed officials did point out that U.S. equities were rather overvalued, with “A few participants” expressing concern that the U.S. equities rally was fueled by speculation rather than fundamentals.