The just released FOMC minutes provided a lot of information on Fed and shows they are real SOB’s.
Sellers of the balance sheet. We learned that the reduction of their Treasury and mortgage holdings may begin as early as the end of this year. The market has been waiting for this day for a long-time. Now it may become a reality and that changes the dynamics of the Treasury and mortgage markets even if it is just a proposal of not reinvesting interest and maturing bonds. The Fed balance sheet is now $4.5 trillion, so there is a lot to sell. There will now be the new issue of balance sheet uncertainty for investor to face. New marginal buyers will have to be found and it will unlikely be at higher Treasury prices. This is not the same as a rate hike. We don’t know the impact of balance sheet reductions.
Overvalued risky asset view. There was talk in the minutes that equities may be overvalued relative to standard models. This should not be considered new news and it should not be a surprise to have the FOMC mention it, but it is always sobering to read central bankers noticing and discussing overvalued financial markets. Investor will have to watch what the Fed may be watching to see if financial markets will affect policies.
Biased risks to upside for growth and inflation. Finally, we have an idea of their view on risks and their general bias is that risks for growth and inflation are more to the upside. If risks are toward the upside, there is less reason for a cautious Fed.
These FOMC minutes tell us that this is not a Fed steeped in extreme caution, but one that is planning the reversal of the big monetary experiment and may be worried about being behind as opposed to ahead of the curve. Of course, these minutes said the economy is doing well and can handle Fed normalization. That may be true, but markets react to policy on the margin. Investors have been euphoric, but now we have less reason to expect fiscal policy help and a central bank that is full speed ahead on normalization. This is bad for risky assets. This is bad for stocks and bonds. Time to get more defensive with investments.