Hello, forex friends! In case you missed them yesterday, the BOC gave its latest monetary policy statement and the minutes of the May FOMC huddle got released. And here are the main takeaways from those two top-tier central bank events that you need to know about.
FOMC Meeting Minutes
The minutes of the Fed’s May monetary policy huddle got released yesterday and the Greenback tumbled lower against its peers. What’s that all about?
Fed members WERE a bit worried about slow growth
In my 5 Highlights from the May FOMC Statement, I pointed out that the Fed downplayed the disappointing GDP growth in Q1 by saying that it “views the slowing in growth during the first quarter as likely to be transitory.”
The minutes reiterated this sentiment because Fed officials think that “much of the recent slowing likely reflected transitory factors, such as low consumer spending for energy services induced by an unusually mild winter and a decline in motor vehicle sales from an unsustainably high fourth-quarter pace.”
However, there was this rather interesting bit from the minutes:
“Members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation.”
As to why the Fed sounded cautious on growth, that’s because Fed officials were not really sure that the softness in consumer spending would be transitory, so much so that “A few [FOMC members] emphasized the uncertainty with regard to the reasons for the unexpected weakness in consumer spending.”
Another rate hike “soon”
Despite the cautious tone on growth, the minutes revealed that:
“Most participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation.”
A “couple” of Fed officials wanted to hike
The Fed unanimously voted to maintain the current monetary policy during the May FOMC statement. Interestingly enough, however, the minutes revealed the following (emphasis mine):
“A couple of participants indicated that increasing the target range for the federal funds rate at the current meeting would be warranted by their economic outlook, but they also noted that maintaining the current stance of policy for now would be consistent with the Committee’s gradual approach or that the Committee’s recent communications had not pointed to an increase at this meeting.”
It therefore looks like there are at least two blatant hawks, although they opted not to vote for a hike in May. Also, the two hawks were not named. Still, that means that the two hawks will likely vote for a June rate since the market is expecting that there’s gonna a rate hike come June.
Balance sheet policy update
The Fed did not provide any updates on the potential balance sheet policy shift during the May FOMC statement. However, the minutes revealed that the FOMC’s staff proposed a “possible operational approach” for reducing the Fed’s balance sheet.
The details are as follows:
“Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger. The caps would initially be set at low levels and then be raised every three months, over a set period of time, to their fully phased-in levels. The final values of the caps would then be maintained until the size of the balance sheet was normalized.”
Wow! That’s sounds so technical and sophisticated, huh?
To help the newbies out there, first understand that the Fed has a humongous balance sheet, thanks to its QE program. To be more specific, the Fed has about $4.5 trillion worth of assets in its balance sheet. And most of those assets are U.S. government bonds and mortgage-backed securities.
And the Fed’s current policy is to maintain its godzilla-sized balance sheet by reinvesting all principal payments back into bonds, thereby putting pressure on bond yields, which helps to keep long-term borrowing costs low.
And in simple English (that can hopefully be understood), the staff proposed that the Fed allow a set amount of its bond holdings to mature. And only the principal payments beyond this set amount would be reinvested. After that, the set amount would be raised every three months until it reaches a predetermined level, which has not been defined yet.
In even simpler terms, the staff proposed that the Fed would unwind its balance sheet slowly at first. The pace of unwinding will then pick up every three months until the maximum predefined pace is reached. After that, just sit back, chillax, and wait until the balance sheet normalizes.
Anyhow, the minutes revealed that “Nearly all policymakers expressed a favorable view of this general approach” because it would reduce the Fed’s balance sheet in a “gradual and predictable manner” and “could help mitigate the risk of adverse effects on market functioning or outsized effects on interest rates.”
Despite the Fed’s cautious tone on growth, odds for a June rate hike held steady at 83.1%, according to the CME Group’s FedWatch Tool, very likely because the Fed also hinted at a rate hike “soon” and because a “couple” of Fed officials said that they would have voted for a rate hike during the May meeting, although they ultimately decided not to.
However, the proposed plan on unwinding the Fed’s balance sheet caused odds for two rate hikes by December to tumble from 53.4% to 45.2%, likely because trimming the Fed’s balance sheet would have a similar tightening effect as a rate hike, which made market players think that further hikes would not be needed. And this fall in future rate hike expectations likely took its toll on the Greenback.
The BOC decided to maintain its current monetary policy as expected. And the Loonie appreciated as a result. Why? What did the BOC have to say in its official press statement? Well, read on and find out.
BOC rather calm on inflation
With regard to headline inflation, the BOC just said that “Inflation is broadly in line with the Bank’s projection in its April Monetary Policy Report,” even though the actual reading missed the BOC’s own forecast.
With regard to the downtrend on two of the BOC’s three measures for core inflation, the BOC just noted in a matter-of-fact manner that “The Bank’s three measures of core inflation remain below two per cent and wage growth is still subdued, consistent with ongoing excess capacity in the economy.”
No sign of worry whatsoever.
BOC mostly optimistic on growth
According to the BOC’s statement, “The Canadian economy’s adjustment to lower oil prices is largely complete and recent economic data have been encouraging, including indicators of business investment.”
The BOC also noted that the consumer spending and the housing market remain “robust” thanks to an “improving” labor market. The BOC does admit that “wage growth is still subdued,” though.
Going back to the housing market, the BOC also said that “Macroprudential and other policy measures, while contributing to more sustainable debt profiles, have yet to have a substantial cooling effect on housing markets.”
This means that the BOC thinks that the Canadian housing market is still relatively stable, although the risk of a housing bubble is still there.
As for trade, the BOC was openly downbeat on that, saying that “export growth remains subdued.” However, the BOC was quick to add that the weakness in export growth is still in-line with the BOC’s forecast.
Finally, the BOC concluded that there will be “very strong growth in the first quarter.” However, the BOC also warned that this “will be followed by some moderation in the second quarter.”
This is not really surprising, though, since the BOC did forecast in its April Monetary Policy Report that growth will moderate a bit, at least on a quarter-on-quarter annualized basis.
No forward guidance, but…
The BOC did not provide any forward guidance, but given the lack of worry on inflation, as well as the BOC’s overall optimistic assessment on growth and constant emphasis that everything was still in-line with its forecasts, it’s probably safe to say that the BOC maintained and plans to maintain its neutral policy bias.
And as a reminder, the BOC switched to a neutral bias during the April BOC statement when BOC Governor Stephen Poloz said the following during the presser (emphasis mine):
“When we [BOC officials] talked about that [a possible rate cut] a few months ago we had seen a series of disappointing data points that led us to believe that the risks were beginning to tilt towards to the downside and the uncertainties that we were dealing with were similarly negative. And so it’s in that context that we discussed the possibility of easing. But in this context, given the data that we’ve seen in the last few months, I can quite clearly say no, a rate cut was not on the table at this time.”
Anyhow, this lack of worry on the part of the BOC and its overall optimistic assessment are very likely the reasons why the Loonie jumped higher as a reaction to the BOC statement.