US equities pulled back as investors feared that the Federal Reserve would start reducing the size of its balance sheet later this year.
The Fed’s decision obviously carries a lot of weight in the stock market. So how can we better understand the policy direction?
Let me first give a brief account of how the Federal Open Market Committee (FOMC) meetings work.
The FOMC holds eight regularly scheduled meetings during the year, and it would release a three-page policy statement after each meeting.
And there would be a press conference for four of the eight regular meetings, which allows Fed chairwoman Janet Yellen to communicate with the market.
Also, the minutes of regularly scheduled meetings are released three weeks after the policy decision.
The minutes offer far more details of the meeting discussions.
FOMC members would usually first discuss the financial market performance, the impact of interest rate policy, economic conditions and prospects.
Then they would vote on whether to change the interest rate policy. All members will also make forecasts on various economic indicators such as GDP growth, inflation, unemployment, interest rates, etc.
The Fed knows well that the minutes of the meetings are widely watched by market participants, therefore, each wording has been carefully chosen in order to get the accurate message across. Investors should pay attention in particular to the choice of words.
For example, FOMC members said in the latest minutes that “real GDP growth was a little weaker, on net, than in the previous projection”, which means the US economic expansion has started to slow down.
So we should watch out if the minutes of the next meeting would take out the word “little”, so it could be a sign that the US economy has hit its peak.
The minutes described inflation as “increasing gradually” and “steadily rising”, which indicate that inflation is on the rise. The Fed therefore looks set to hike interest rates by at least three times this year and next.
Also, investors should look for any new topics in the meeting. For the first time, the March meeting mentioned reducing the size of the balance sheet.
“Many participants emphasized that reducing the size of the balance sheet should be conducted in a passive and predictable manner,” it said.
“Many” gives you an idea how uniform the opinions are on the committee.
It emphasized that the process will be “passive” and “predictable”, hinting that any move won’t be drastic and the impact on US equities would hence likely to be limited.
How would that impact Hong Kong?
The city’s housing prices have soared for past decade due to US monetary easing. As the Fed is set to tighten further, Hong Kong banks will have to hike rates sooner or later under the currency peg system.
This article appeared in the Hong Kong Economic Journal on April 12
Translation by Julie Zhu
[Chinese version 中文版]
– Contact us at [email protected]