When it comes to central bank policymaking, the policy meeting minutes published subsequently are often as important as the interest rate announcement itself. The minutes reveal the substance of the debate and discussion in arriving at the outcome, and how the members of the committee voted.
Eagerly anticipated in the light of December’s unanimous decision by the US Federal Reserve to keep interest rates on hold again, but in a change of tenor strongly hinting that rates would be lower by the end of 2024, the minutes of that meeting were expected to reveal a sea-change in the Fed’s economic outlook. The reality was far less a sea-change than a distinctly damp squib. It was a masterclass in qualification and obfuscation. The summary can effectively be distilled down to: ‘we’re hoping the economy is slowing and that wages are moderating: the indicators are gradually pointing the right way but there is great uncertainty. Inflation appears to be falling towards 2% but we’re not sure whether that is sustainable. On balance we think interest rates are likely to be lower by the end of 2024 than today, but they might be the same or possibly higher’. There you have it: whatever the actual outcome, the Fed can say ‘we told you so.’ Much of the committee’s discussion was about the significant fall in bond yields in the fourth quarter and what markets were implying about future inflation trajectories and interest rates to match: perhaps useful context for the policy wonks but hardly value-added material for investors to be told what they themselves already think.
Eagerly anticipated in the light of December’s unanimous decision by the US Federal Reserve to keep interest rates on hold again, but in a change of tenor strongly hinting that rates would be lower by the end of 2024, the minutes of that meeting were expected to reveal a sea-change in the Fed’s economic outlook. The reality was far less a sea-change than a distinctly damp squib. It was a masterclass in qualification and obfuscation. The summary can effectively be distilled down to: ‘we’re hoping the economy is slowing and that wages are moderating: the indicators are gradually pointing the right way but there is great uncertainty. Inflation appears to be falling towards 2% but we’re not sure whether that is sustainable. On balance we think interest rates are likely to be lower by the end of 2024 than today, but they might be the same or possibly higher’. There you have it: whatever the actual outcome, the Fed can say ‘we told you so.’ Much of the committee’s discussion was about the significant fall in bond yields in the fourth quarter and what markets were implying about future inflation trajectories and interest rates to match: perhaps useful context for the policy wonks but hardly value-added material for investors to be told what they themselves already think.
One for the yield curve anoraks
But there were nuggets of useful insight. One was the Fed’s quantification of the changing shape of the yield curve. “Models, on average, suggested that about two-thirds of the decline in longer-term yields on Treasury securities over the period (i.e. between the November and December policy meetings) was attributable to a reduction in term premiums and about one-third to a decline in expectations for the policy rate”. A conventional yield ‘curve’ is a line which rises from bottom left to top right on the graph, on the basis that an investor in a fixed income bond requires less of a return for an investment with a very short time horizon (i.e. he/she can see what is more-or-less in front of their nose) than one with a long duration where the predictability of the outcome diminishes as the uncertainty increases over time. In lay terms, what the Fed was saying here was that despite that natural uncertainty associated with duration, on a ratio of 2:1 investors were more at ease with the associated risks of having their money tied up for a long period than being preoccupied with the underlying interest rate policy itself (this is on the basis that the long-term assumption is that inflation will be reasonably stable in line with the central banks’ mandated target of 2%, therefore any volatility in bond yields either side of the mean is the implied appetite for taking or avoiding risk over that period).
As we observed in these columns before Christmas when bond yields were tumbling (and prices were heading as equally rapidly upwards), as well as pragmatic analysis of the economic outlook, for investors there was a powerful behavioural factor at work: backed by reported economic data working in their favour, it was the opportunity to recoup some of the significant losses incurred in 2022 and through to mid-October 2023, and those opportunities were greater among bonds with longer duration and higher natural volatility. The implicit warning is that what happened late last year in terms of market behaviour cannot be seen as a permanent state of affairs. It seems obvious that polarised opinions separating markets from policy are unsustainable: both cannot simultaneously be enduringly correct.
As we observed in these columns before Christmas when bond yields were tumbling (and prices were heading as equally rapidly upwards), as well as pragmatic analysis of the economic outlook, for investors there was a powerful behavioural factor at work: backed by reported economic data working in their favour, it was the opportunity to recoup some of the significant losses incurred in 2022 and through to mid-October 2023, and those opportunities were greater among bonds with longer duration and higher natural volatility. The implicit warning is that what happened late last year in terms of market behaviour cannot be seen as a permanent state of affairs. It seems obvious that polarised opinions separating markets from policy are unsustainable: both cannot simultaneously be enduringly correct.
Supply chain observations through the Fed’s domestic prism
A second insight was a prolonged discussion among the participants about the economy. It was noted that the inflationary effect arising from the significant hiatus in global supply chains beginning early in 2020 with the onset of the pandemic and China going into lockdown, soon to be followed by most of the world, is no longer a factor. Supply chains are normal again. However, the Fed’s policy meeting took place just as the Iranian-backed Houthi rebels were beginning their terrorist campaign against merchant shipping in the Red Sea and the Gulf of Aden while simultaneously the Panama Canal was and is still also facing transit restrictions thanks to a lack of water.
Estimates vary but between 12-15% of all global trade goes through the Red Sea. It is one of the world’s busiest maritime routes and the Suez Canal at the Mediterranean end and the Bab El Mandab Strait at the bottom out to the Gulf are two of the six great maritime choke points globally (Panama, the Gibraltar Straits, the Straits of Hormuz and the Straits of Malacca are the others; secondary constrictions include the Dover Strait, the Bosphorus and the Great Belt restricting sea room between the Baltic and the North Sea). As things stand today, re-routing shipping around the Cape of Good Hope to avoid danger in the Red Sea is an inconvenience; the consequential delays and disruption are nothing compared to the scale of what happened in 2020-2022 thanks to the pandemic and Putin’s invasion of Ukraine (if 15% of global shipping is directly affected, by definition 85% is not). However, the Fed also looks at supply chains from its own narrow domestic point of view. Despite being the world’s biggest economy at a quarter of global GDP, it is remarkably insular and relative to its size much less mercantile than its main competitors (in particular being almost self-sufficient in oil). When the Fed observes that supply chains have normalised, what they mean is that supplies to and from the US are normal again. But there are two qualifications to that: first, thanks to the Houthis, things have moved on; second, the Fed’s observations should not be extrapolated as being equally applicable to everyone else.
Estimates vary but between 12-15% of all global trade goes through the Red Sea. It is one of the world’s busiest maritime routes and the Suez Canal at the Mediterranean end and the Bab El Mandab Strait at the bottom out to the Gulf are two of the six great maritime choke points globally (Panama, the Gibraltar Straits, the Straits of Hormuz and the Straits of Malacca are the others; secondary constrictions include the Dover Strait, the Bosphorus and the Great Belt restricting sea room between the Baltic and the North Sea). As things stand today, re-routing shipping around the Cape of Good Hope to avoid danger in the Red Sea is an inconvenience; the consequential delays and disruption are nothing compared to the scale of what happened in 2020-2022 thanks to the pandemic and Putin’s invasion of Ukraine (if 15% of global shipping is directly affected, by definition 85% is not). However, the Fed also looks at supply chains from its own narrow domestic point of view. Despite being the world’s biggest economy at a quarter of global GDP, it is remarkably insular and relative to its size much less mercantile than its main competitors (in particular being almost self-sufficient in oil). When the Fed observes that supply chains have normalised, what they mean is that supplies to and from the US are normal again. But there are two qualifications to that: first, thanks to the Houthis, things have moved on; second, the Fed’s observations should not be extrapolated as being equally applicable to everyone else.
A persistent rain cloud: US government debt
But away from direct preoccupations with the Fed, inflation and interest rates, an enduring problem is still gnawing away rapidly returning to the foreground: the political deadlock in Congress and the failure to resolve government expenditure and its borrowing limits. Congress has two self-imposed phased deadlines looming, 19th January and 2nd February, beyond which virtually all government spending will be suspended and public services will close. There is an alternative which is that it agrees to keep talking and to set yet another deadline for the spring though many in both the House and the Senate see a third compromise in 12 months to keep kicking the can down the road as politically untenable.
In a Congress finely balanced politically, and in what is about to be the most extraordinary electoral spectacle in living memory, this is a game of bluff with enormous consequences. At best, a substantive deal may yet be reached but it needs to be enduring and demonstrably deliverable in the way the one agreed last June (following the debt ceiling breach last January) was not. Under the kick-the-can scenario, the US looks incompetent at managing its fiscal affairs, the debt mountain continues to accumulate but the election will eventually create some form of resolution. At worst, Congress is forced either to close all public services with significant political consequences for both parties, or services are maintained and the Armageddon financial risk is the government defaults on its loans. The consequences for the Ukrainian war effort are significant too: although a small $250m immediate relief package was authorised on 27 December by Biden under Presidential Decree as the final package for 2023, substantially the flow of military aid to Ukraine from the US will rapidly dry up in 2024 until the Congressional deadlock is broken.
In a Congress finely balanced politically, and in what is about to be the most extraordinary electoral spectacle in living memory, this is a game of bluff with enormous consequences. At best, a substantive deal may yet be reached but it needs to be enduring and demonstrably deliverable in the way the one agreed last June (following the debt ceiling breach last January) was not. Under the kick-the-can scenario, the US looks incompetent at managing its fiscal affairs, the debt mountain continues to accumulate but the election will eventually create some form of resolution. At worst, Congress is forced either to close all public services with significant political consequences for both parties, or services are maintained and the Armageddon financial risk is the government defaults on its loans. The consequences for the Ukrainian war effort are significant too: although a small $250m immediate relief package was authorised on 27 December by Biden under Presidential Decree as the final package for 2023, substantially the flow of military aid to Ukraine from the US will rapidly dry up in 2024 until the Congressional deadlock is broken.
Change of sentiment?
As we have said before when commenting on monetary policy in these columns, 2023 was another year of epic struggle between markets and central banks fundamentally disagreeing about policy (indeed views among investors were also divided, as were those among the experts on the central banks’ policy boards). The very fact of the extreme volatility in bond yields seen over the past two years is incontrovertible evidence that there was no consensus. For what it is worth, even though the Fed is currently pointing to any relaxation in interest rates being towards the end of the year, markets as ever are ahead of the game predicting a 70% likelihood that the Fed will begin cutting as soon as March. Even in its determination to bury its meaning and leave all doors open, the Fed has already conceded ground. If some of their enthusiasm has been curbed (a 90% chance of a rate cut in March was priced in before the publication of the latest minutes), investors remain determined to smoke the central banks out of their trenches, not just the Fed but also the Bank of England and the European Central Bank. And as if the Fed isn’t already preoccupied enough with investors, with only 10 months to go to election day to pick a new President, it’s sure to be put under increasing political pressure by both sides.
Who would be a central banker, eh?
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
Who would be a central banker, eh?
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
Authors
Investment Manager, Jupiter Independent Funds/Merlin
Investment Manager & ESG Investment Director, Independent Funds/Merlin
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