Some Federal Reserve policy makers were concerned investors may be getting too complacent and indicated they’re on the lookout for excessive risk-taking, minutes of their June meeting show.
Officials also moved closer to deciding on the main tool they will use to tighten monetary policy when the time comes, most likely next year, and agreed they’ll end their asset- purchase program in October if the economy holds up.
Fed officials expressed concern about low volatility in equity, currency and fixed-income markets, with some saying investors aren’t factoring enough uncertainty into the outlook for the economy and monetary policy. At the same time, the officials said the central bank should continue to support favorable financial conditions needed to sustain growth, according to the minutes.
Five years into an expansion, officials are preparing plans to wind down the most aggressive stimulus in the central bank’s history without roiling markets. The improving U.S. economy and Fed pledges to do what it takes to preserve the momentum have almost tripled U.S. stock prices since 2009 and pushed swings across asset prices to new lows.
“The Fed is still the investor’s friend, not something to be feared,” said Brian Jacobsen, who helps oversee $231 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “Where there are bubbles, the Fed will use its role as a regulator and supervisor to address those problems. It will not use monetary policy.”
St. Louis Fed President James Bullard, in an interview yesterday, said “financial stability has to be a top concern of the committee following the financial crisis.”
‘Bubble Process’
Even so, he said, he has seen nothing “to date that is so severe that I would bring it in as a top concern for monetary policy.” The greater concern is interest rates “that are possibly too low the next couple of years,” and that could “get into feeding into some kind of bubble process.”
U.S. stocks extended gains after release of the minutes, climbing back toward a July 3 record after falling for two days. The Standard & Poor’s 500 Index added 0.5 percent to close at 1,972.83 in New York. The yield on the 10-year Treasury note fell one basis point, or 0.01 percentage point, to 2.55 percent.
Most Federal Open Market Committee participants agreed that the interest rate on excess reserves banks keep on deposit at the Fed “should play a central role” in the exit from extraordinary monetary stimulus, according to minutes of the June 17-18 meeting released yesterday in Washington.
More Depth
“This is the first set of minutes that have really gone into more depth about the specific tools that they’ll use when it comes to normalization,” said Kim Chase, a Houston-based senior economist for Spain’s Banco Bilbao Vizcaya Argentaria SA. “Slowly but surely they’re starting to give away a few more details. It’s positive from the market standpoint that they’re discussing it more and maybe are on a clearer path.”
Officials agreed their asset purchases would end with a final reduction of $15 billion after their October meeting if the economy progresses as they expect. The FOMC continued cutting the monthly pace of asset purchases in June, reducing it by $10 billion for a fifth straight meeting, to $35 billion.
Fed Chair Janet Yellen repeated at her press conference after the meeting the Fed is likely to reduce the pace of bond buying “in further measured steps.” Yellen is scheduled to deliver her semiannual testimony to the Senate July 15 and the House the next day.
The Fed’s asset buying has boosted the central bank’s balance sheet to a record $4.38 trillion, and volatility is low worldwide.
Volatility Index
The Chicago Board Options Exchange Volatility Index, which tracks contracts to protect against S&P 500 declines, remains near last week’s seven-year low of 10.32, about half its 20.05 average over its 24-year history. The Bank of America Merrill Lynch MOVE Index, which measures Treasury price swings based on options, and swings in the dollar versus the yen, both remain near record lows.
Officials last month agreed they must monitor markets for signs of froth and said that if necessary, supervisory measures should be used to “address excessive risk-taking and associated financial imbalances,” minutes show.
Central bankers last month also raised their forecasts for interest-rate increases. They estimated the main rate will be 1.13 percent at the end of 2015 and 2.5 percent a year later. In March, they forecast 1 percent at the end of next year and 2.25 percent in 2016.
Employment Goal
Fed officials are closing in on their goal of full employment faster than they had forecast, forcing them to consider accelerating their first increase in the main interest rate in eight years. The Fed has said rates are likely to remain low for a “considerable time” after it ends large scale asset purchases that are set to wind down by year end.
Payrolls surged in June by 288,000 workers, the Labor Department said last week. The jobless rate fell to 6.1 percent, a level that policy makers didn’t expect to see before the end of the year.
The minutes offered no new clues on the timing of an interest-rate increase, with officials saying policy depends most “on the evolution of the economic outlook.” The federal funds rate, which represents the cost of overnight money in the interbank market, has been held near zero since December 2008.
Central bankers continued discussing a strategy for the eventual exit from monetary easing. “It was observed that it would be useful for the committee to develop and communicate its plans to the public later this year, well before the first steps in normalizing policy become appropriate.”
‘Supporting Role’
One tool, known as the overnight reverse repurchase facility, “could play a useful supporting role,” according to the minutes. The tool could be used to set the lowest rate at which holders of cash would be willing to lend.
The Fed now pays 0.25 percent interest on bank reserves deposited overnight at the central bank. By contrast, it pays 0.05 percent on cash it borrows through its reverse repo facility, which is used by institutions such as money-market funds, which can’t deposit money at the Fed.
“With the labor market improving and the inflation data tilting higher, Fed officials feel some pressure to express a coherent exit strategy, even though many would agree that we’re still far away,” said Dana Saporta, a U.S. economist at Credit Suisse Group AG in New York.
Many participants agreed that it “would be best” for the Fed to end reinvestment of maturing securities only when it raises rates for the first time since 2006, or even afterward. Most preferred to end after.
That suggests the Fed is comfortable operating with a “very high balance sheet” and has no desire to stop reinvesting until after it begins to raise rates, according to Eric Green, global head of foreign exchange and rates at TD Securities USA LLC in New York.