Initial Enthusiasm At Fed Minutes From December Fades In Afternoon

So what, exactly, didn’t the markets like about the minutes of the Federal Reserve’s December meeting?

After an initial spike to the day’s high at 2595 at 2:09 p.m. New York time, nine minutes after the 2:00 p.m. release of the minutes, the Standard & Poor’s 500 went into reverse, finishing the day at 2584. That was still good for a gain of 0.41%.

One possibility is that investors and traders were hoping for something in the minutes more forceful that a promise that the central bank would be “patient” about raising interest rates in 2019.

That was the message in the Fed’s post-meeting statement and in speeches over the last few days from Federal Reserve presidents and officials.

And if that was the hope, markets didn’t get it. Officials signaled that further gradual increases in the policy rate were likely, though several participants said that it might be appropriate “over upcoming meetings to remove forward guidance entirely.” They suggested replacing it with language emphasizing “the data-dependent nature” of monetary-policy decisions.

The other possibility, and personally I find this more likely, is that investors and traders used those 9 minutes to read deeper into the minutes and didn’t like what they saw about the Fed’s balance sheet. In the meeting’s discussion about “normalizing” the Fed’s balance sheet–that is shrinking it to something like its pre-global financial crisis size, some participants suggested that the Fed would take a faster approach to reducing its holdings of mortgage-backed securities than the passive track that the Fed is following now. A more active approach would involve actually selling mortgage-backed securities, a huge portion of the Fed’s assets–instead of the current policy of simply non rebuying mortgage-backed securities when they mature.

I think the Fed is a long way away from actively selling either mortgage-backed securities or Treasuries, but the financial markets are already worried about the tighter liquidity that results from the passive “let them mature and don’t replace them policy.”

Several economists and market strategists on Wall Street have recent pointed out that shrinking the Fed balance sheet has more influence on market liquidity than another increase or two in the Fed’s benchmark short-term interest rates. The market is hoping to hear that the Fed is cutting back on the pace of its balance sheet reductions. Nothing in today’s minutes was supportive of that hope.