Federal Open Market Committee meeting minutes from May 3-4, 2022 - Full TEXT

Federal Open Market Committee meeting minutes from May 3-4, 2022 - Full TEXT

Developments in Financial Markets and Open Market Operations
The manager turned first to a discussion of monetary policy expectations in the United States. Federal Reserve communications since the March FOMC meeting were perceived as signaling a more rapid removal of policy accommodation than had been expected, resulting in significant shifts in expectations regarding the path of the federal funds rate. For the current meeting, federal funds futures implied around 50 basis points of policy rate tightening, and Open Market Desk survey respondents assigned an average probability of 80 percent to that outcome. The median Desk survey respondents also projected 50-basis-point increases in the target range at the two following meetings and another 125 basis points of increases by the middle of next year, bringing the projected midpoint of the target range to a peak of 3.13 percent-substantially higher than in previous surveys. Market participants continued to note significant uncertainty regarding the economic outlook and the degree of policy tightening ahead. This uncertainty was reflected in the dispersion in survey respondents' average probability distribution for the target range at the end of 2023.

Regarding the outlook for runoff of the Federal Reserve's securities holdings, market participants widely expected the Committee to announce the commencement of balance sheet runoff at the current meeting. Median survey responses suggested that most market participants anticipated maximum redemption caps of $60 billion per month for Treasury securities and $35 billion per month for agency mortgage-backed securities (MBS), with the caps phased in over roughly three months. Survey responses continued to reflect substantial dispersion in views on the level of System Open Market Account (SOMA) holdings at which balance sheet runoff would end.

The manager turned next to a discussion of U.S. financial market developments. Financial conditions tightened notably over the period. Treasury yields increased across the curve, with the rise primarily reflecting higher real interest rates. Longer-term private borrowing rates also moved higher, with 30-year fixed-rate mortgage rates rising above 5 percent to the highest levels in over a decade. Equity indexes ended the period substantially lower, on net. These indexes moved up earlier in the period in connection with a perceived reduction in tail risks stemming from the war in Ukraine but then moved lower, reportedly because of increased caution regarding the economic outlook amid the expected tightening in U.S. monetary policy. The dollar appreciated, leaving the broad trade-weighted dollar up around 2 percent over the period. Viewed over a longer time horizon, financial conditions, as measured by many financial conditions indexes, had tightened by historically large amounts since the beginning of the year.

Market- and survey-based measures of U.S. inflation expectations continued to project a significant deceleration in inflation in the coming years. Nonetheless, far-forward inflation compensation rose over the period, and market participants remained attentive to the risk that, in bringing inflation back to 2 percent, the Committee would need to tighten by more than currently expected.

In global financial developments, many advanced-economy central banks raised policy rates over the period, and investors increasingly came to anticipate tighter monetary policy ahead in most advanced foreign economies. The Bank of Japan was an exception and was widely anticipated to maintain its accommodative policies. The yen depreciated 9 percent against the dollar over the intermeeting period to its weakest level in over two decades. Emerging market (EM) currencies remained relatively resilient. Market participants focused on the spread of COVID-19 in China and the effect of zero-COVID policies, which had resulted in increasingly widespread lockdowns. The renminbi depreciated against the dollar around 4 percent over the intermeeting period.

The manager turned next to a discussion of developments in money markets. The effective federal funds rate rose 25 basis points following the increase in the target range at the March FOMC meeting and remained stable throughout the period. Secured overnight rates also rose by 25 basis points following the March meeting, though modest softness emerged in subsequent days. Market participants noted that ongoing uncertainty about the near-term path of Federal Reserve policy had increased demand for very short-dated investments. This demand, combined with declining Treasury bill supply, contributed to the downward pressure on secured rates and to rising overnight reverse repurchase agreement (ON RRP) usage. The manager expected that ON RRP usage could remain elevated in coming months but anticipated that, over the longer term, usage would decline as balance sheet reduction proceeded.

The manager indicated that the Desk was prepared to implement the Committee's plan for balance sheet reduction and that, in the event that the Committee announced the plan at the end of the current meeting, the Desk would issue a statement and FAQs providing the public with details regarding the implementation of the plan. The Desk would closely monitor market conditions and update the Committee during the runoff process.

The deputy SOMA manager reviewed developments concerning Desk operations. The Desk planned to increase the publication frequency of data on ON RRP usage. This additional information would provide the public with greater transparency about usage of the ON RRP facility. The Desk planned to publish the SOMA annual report soon. In addition to the detailed review of open market operations over 2021, the report would include updated illustrative projections of the size and composition of the Federal Reserve's balance sheet over coming years. With respect to other operational matters, the Desk continued to work on details of plans for agency MBS CUSIP (Committee on Uniform Security Identification Procedures) aggregation and anticipated that this process would begin in coming months. Finally, the deputy manager requested that the Committee vote to maintain the standing U.S. dollar and foreign currency liquidity swap arrangements and to renew the reciprocal currency arrangements with Canada and Mexico under the North American Framework Agreement. In their discussion, participants widely agreed that the standing swap lines are a critical tool allowing the Federal Reserve to address global dollar funding pressures that could otherwise adversely affect the U.S. economy.

The Committee voted unanimously to renew the reciprocal currency arrangements with the Bank of Canada and the Bank of Mexico; these arrangements are associated with the Federal Reserve's participation in the North American Framework Agreement of 1994. In addition, the Committee voted unanimously to renew the dollar and foreign currency liquidity swap arrangements with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. The votes to renew the Federal Reserve's participation in these standing arrangements occur annually at the April or May FOMC meeting.

By unanimous vote, the Committee ratified the Desk's domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System's account during the intermeeting period.

Staff Review of the Economic Situation
The information available at the time of the May 3-4 meeting suggested that U.S. real gross domestic product (GDP) declined in the first quarter. However, first-quarter growth in private domestic final demand was faster than in the previous quarter, while labor market conditions tightened further in March. Consumer price inflation through March-as measured by the 12?month percentage change in the price index for personal consumption expenditures (PCE)-remained elevated.

Total nonfarm payroll employment rose in March, and the unemployment rate declined to 3.6 percent. The unemployment rates for African Americans and for Hispanics moved lower, though both rates remained noticeably higher than the national average. The labor force participation rate increased in March, as did the employment-to-population ratio. The private-sector job openings rate, as measured by the Job Openings and Labor Turnover Survey, remained elevated. The employment cost index of hourly compensation in the private sector rose 4.8 percent over the 12 months ending in March; this gain was much larger than the corresponding 12?month changes posted in each of the preceding four years and was the largest 12?month increase since 1990.

Consumer prices continued to rise rapidly. Total PCE price inflation was 6.6 percent over the 12 months ending in March, and core PCE price inflation, which excludes changes in consumer energy prices and many consumer food prices, was 5.2 percent over the same period. The trimmed mean measure of 12?month PCE price inflation constructed by the Federal Reserve Bank of Dallas was 3.7 percent in March, 2 percentage points higher than its year-earlier rate of increase. A new version of the staff's common inflation expectations index, which combines information from many indicators of inflation expectations and inflation compensation, moved up in the first quarter and was at the upper end of the range of values seen since 2005.

Both real PCE and residential investment increased in the first quarter at rates similar to those seen in the fourth quarter of 2021. Business fixed investment growth picked up sharply in the first quarter, with spending on equipment and intellectual property products posting a large increase. Inventory investment moved lower after surging in the fourth quarter of 2021, and total real government purchases declined further, led by a drop in defense purchases.

The U.S. international trade deficit widened further in the first quarter of this year, and net exports made a large negative contribution to real U.S. GDP growth. Goods imports continued the fourth quarter's strong growth, driven by large increases in real imports of consumer goods, capital goods, and automotive products. By contrast, real exports of goods fell back after rising briskly late last year, with broad-based declines in most major categories. Both real exports and imports of services grew at a moderate pace in the first quarter, though both were held back by a tepid recovery in international travel amid ongoing waves of COVID-19.

Data suggested that foreign economic growth remained solid in the first quarter, as most economies continued to show adaptability to new COVID-19 waves. Chinese data for March and April, however, showed declines in manufacturing and services activity and worsening supply bottlenecks after Chinese authorities locked down Shanghai and other cities to combat the spread of the Omicron variant. The ongoing Russian invasion of Ukraine also left its imprint on foreign economies, with consumer and business sentiment declining in Europe and global prices of a range of commodities continuing to rise. Foreign inflation increased significantly further, driven by surging energy and food prices as well as some broadening of price pressures to core goods and services. In response, many central banks around the world tightened their monetary policy stances.

Staff Review of the Financial Situation
U.S. Treasury yields and the market-implied federal funds rate path moved substantially higher over the intermeeting period as Federal Reserve communications and domestic economic data releases were perceived as suggesting that a more aggressive tightening of monetary policy was likely over coming months. Sovereign yields in advanced foreign economies (AFEs) also increased notably. Broad domestic equity price indexes declined on net, and the one-month option-implied volatility on the S&P 500 index-the VIX-remained elevated. Short-term funding markets were stable, while participation in the ON RRP facility increased further. Amid the increase in Treasury yields, borrowing costs increased in many sectors and were at or somewhat above pre-pandemic levels.

Since the March FOMC meeting, 2-, 5-, and 10-year Treasury yields increased significantly on net. The increases in nominal Treasury yields were primarily accounted for by rising real yields, while inflation compensation implied by Treasury Inflation-Protected Securities was little changed. Alongside moves in shorter-term Treasury yields, the expected federal funds rate path-implied by a straight read of overnight index swap quotes-rose notably since the March FOMC meeting.

Broad equity indexes decreased over the intermeeting period. Early in the period, equity prices increased, supported by the robust pace of economic activity and reduced market concerns about the implications for the global economy of Russia's invasion of Ukraine. The initial sharp gains in stock prices were followed by larger declines later in the period, as longer-term interest rates rose substantially and as some disappointing earnings reports toward the end of the intermeeting period weighed on equity prices. The VIX declined substantially early in the period but ended the period little changed on net, remaining at elevated levels. Similarly, spreads on investment- and speculative-grade corporate bonds narrowed moderately earlier in the intermeeting period and then widened, ending the period only slightly narrower, on net, and below the median of their historical distribution. Spreads on municipal bonds were up modestly and stood at about the 90th percentile of their historical distribution.

Conditions in short-term funding markets remained stable over the intermeeting period, with the March increase in the Federal Reserve's administered rates passing through to overnight money market rates. Secured overnight rates softened later in the period, with downward pressure on rates attributed to continuing declines in net Treasury bill issuance, increased activity in certain segments of the repo market that tend to trade at lower rates, and money market funds continuing to shorten portfolio maturities amid uncertainty about the pace of anticipated policy rate increases. Consistent with the downward pressure on repo rates, daily take-up in the ON RRP facility remained elevated.

Spreads on most types of longer-tenor commercial paper and negotiable certificates of deposit narrowed, reportedly reflecting reduced market concerns about the effects of Russia's invasion of Ukraine, although some of the spreads remained slightly wider than those seen earlier this year.

Over the intermeeting period, sovereign yields in AFEs increased notably because of concerns about further inflationary pressures, some central bank communications that were perceived as less accommodative than expected, and spillovers from rises in U.S. Treasury yields. Prospects of tighter monetary policy and COVID-related lockdowns in China weighed on prices of risky assets, but investor concerns surrounding the economic effects of the war in Ukraine seemed to abate partially. On balance, major foreign equity indexes registered mixed and relatively modest changes. The U.S. dollar generally strengthened, with a more pronounced dollar appreciation against AFE currencies, as U.S. Treasury yields generally rose more than their AFE counterparts. Among EM currencies, the dollar appreciated significantly against the Chinese renminbi.

Over the intermeeting period, along with the increase in Treasury yields, borrowing costs increased in many sectors and were at or somewhat above pre-pandemic levels. Credit remained widely available, and borrower credit quality continued to be strong overall.

Borrowing costs for residential mortgage loans increased substantially, with the 30-year mortgage offer rates reaching levels not seen since 2010. This increase largely reflected the rise in the 10-year Treasury yield. Corporate bond yields also increased, although the effect of the increase in Treasury yields was partly offset by narrower spreads. Municipal bond yields also increased notably.

Bank loan rates for commercial borrowers increased and rates on large syndicated loans were roughly in line with pre-pandemic levels. In consumer credit markets, rates on auto loans and new credit card offers continued to trend upward.

Credit, which remained widely available for most types of borrowers, was broadly in line with pre-pandemic levels. Gross nonfinancial corporate bond issuance rebounded sharply in March, mostly reflecting an increase in investment-grade issuance, while gross institutional leveraged loan issuance slowed amid elevated geopolitical uncertainty.

Commercial and industrial (C&I) loans and commercial real estate (CRE) loans on bank balance sheets also grew robustly in March. Respondents in the April Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) reported a continued easing of lending terms and strengthening demand for C&I loans as well as easing standards for multifamily CRE loans.

For most small businesses, credit appeared to be available, although these businesses' demand for credit reportedly remained weak. In the April SLOOS, large banks reported unchanged standards on C&I loans to small firms, while small banks tightened standards modestly to such firms.

In consumer credit markets, credit card balances grew strongly in the first quarter amid easing standards and greater utilization, and auto credit outstanding continued to grow steadily through February despite vehicle production shortfalls and low vehicle inventories. Residential mortgage credit conditions remained accommodative through March, despite the increase in mortgage interest rates, particularly for stronger borrowers who met standard loan criteria.

The credit quality of firms, municipalities, and households remained strong overall. The volume of credit rating upgrades for corporate bonds outpaced downgrades moderately in March, continuing a nearly yearlong pattern. The credit quality of C&I loans on banks' books continued to be strong as delinquency and default rates both remained low. Delinquency rates on bank and nonbank loans to small businesses edged down in February, while in the CRE sector, borrower financial health continued to recover. Household credit quality remained strong, and delinquency rates across both prime and nonprime borrowers continued to be subdued by historical standards.

The staff provided an update on its assessment of the stability of the financial system. The staff judged that, amid a substantial upward shift in interest rates, Russia's invasion of Ukraine, and ongoing disruptions to supply chains, the financial system-outside of commodities markets-had been resilient. However, larger or prolonged disruptions in commodities markets could interfere with other markets and real activity more broadly. To date, however, such potential spillovers appeared to be limited.

The staff noted that increased uncertainty and ongoing volatility had reduced risk appetite in financial markets and eased price pressures, although valuations of many assets remained elevated. CRE valuations appeared somewhat elevated except for sectors that were affected most by the pandemic. Residential house prices had risen rapidly, although the staff continued to see key differences from the previous debt-fueled housing boom: The mortgage finance reforms enacted after 2008 limited the potential for significant deterioration in underwriting standards, most new mortgage debt had been added by borrowers with prime credit scores, and homeowners' equity positions were healthy.

The staff assessed that aggregate household and business leverage was moderate. Households' debt-to-GDP ratio remained r