The eagerly awaited release of the FOMC minutes revealed little, but two potential nuggets were uncovered and we will watch to see if they turn into valuable assets. The first was the discussion of the FIXED-RATE, FULL-ALLOTMENT OVERNIGHT REVERSE REPURCHASE AGREEMENT (also known as the O/N RRP). This is a very sophisticated monetary tool that the Fed hopes to utilize to resolve the “FORWARD PROBLEM” of excess reserves in the banking system. The System Open Market Account (SOMA) has been testing the O/N RPP since September to ensure that SOMA can handle the use of the facility as an active tool of policy, possibly utilizing it as the workhorse of the issue of EXCESS RESERVES after the massive Fed QE programs. In quoting from the text: “The proposed increase in caps was intended to test the Desk’s ability to manage somewhat larger operational flows and to provide additional information about the potential usefulness of O/N RPP operations to affect market interest rates when doing so becomes appropriate.” This is an issue that will prove market moving on a regular basis as the operational flows grow in size. (I will cover this in-depth in another piece).
The second nugget was the paragraph about forward guidance that I wrote about following the FOMC statement on December 18. From the MINUTES: “A number of members thought that the forward guidance should emphasize the importance of inflation as a factor in their decisions. Accordingly, almost all members agreed to add language indicating the Committee’s anticipation, based on its current assessment of additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments, that it would be appropriate to maintain the current target range for the federal funds rate WELL PAST THE TIME THAT THE UNEMPLOYMENT RATE DECLINES BELOW 6 1/2 percent, especially if projected inflation continues to run below the Committee’s longer-run objective.”
This helps to clarify that much discussion about lowering the THRESHOLD took place and this language seemed to over a compromise to a FED struggling to utilize the toll of forward guidance. In my opinion, had the Fed appeared to be lowering the threshold on unemployment so soon, it would have provided the market with a sense that Ms. Yellen was an uber-dove and having an immediate impact. WELL PAST THE TIME is a verbal balancing of the forward guidance and I make no qualitative judgement about it, just note its importance.
***Tomorrow, the Bank of England announces its interest rate decision and consensus calls for no change. The rate will remain at 0.50% and the asset purchase program will remain at 375 billion pounds. Governor Mark Carney has no reason to rock the boat as the U.K. is growing and the British pound is relatively strong of late but nothing dramatic. The European Central Bank (ECB) announces its decision at 6:45 a.m. CST and is widely expected to keep the overnight rate at 0.25% while it maintains it interest on reserves at ZERO. The ECB will be content to sit tight now that the EURO has fallen a little and the European banks are trying to get their balance sheets in position for the long-awaited asset quality review (AQR). The world is convinced that the European banking crisis has been resolved so President Draghi will not want to upset common wisdom by calling unneeded attention to bank problems. Draghi’s news conference at 7:30 will be one of the best song and dance routines since Singin’ In The Rain. Again, expect nothing from the ECB President.
***Today’s FOMC RELEASE set the yield curves in motion, especially the 5/30 curve, which has been a barometer for NOTES FROM UNDERGROUND. Since the Fed’s December 18 meeting, the 5/30 curve has flattened dramatically but today it broke out of its recent range. As I discussed with Rick Santelli and in this blog ad nauseam, the FIVE-YEAR NOTE has been the safety play for many investors in the time of non-tapered QE. The problem with the FIVE-YEAR NOTE has been that it failed to pay any duration risk whereas the 10- and 30-year bonds have had a net positive REAL YIELD. The market has a fear that any actually FED tightening has not been priced into the FIVE-YEAR. From the continued market action it appears as if some large investor is caught the wrong way in the yield curve and if the public voice of Bill Gross is to be believed it must be PIMCO as he spent much time gloating about how correct he was after the Fed failed to taper at the September meeting. It is difficult to enter the trade while elephants are retreating from the waterhole (Victor Niederhoffer), but it is something to keep aware of as traders. The market indeed is a cruel mistress and humility is a dish best eaten warm.