Market Commentary: The Boardroom

by Gayl Mileszko

The Boardroom

The Federal Open Market Committee began its most recent policy meeting on Tuesday at 10:00 a.m. in the offices of the Board of Governors located in the Marriner S. Eccles Building at the intersection of the 20th Street and Constitution Avenue in Washington, D.C. The elite 12-member group has been meeting at that location since President Franklin Roosevelt dedicated the building on October 20, 1937. The Board Room is two-stories high with a 1,000-pound brass and glass chandelier at the center, a large map of the United States painted by mural artist Ezra Winter on one wall, and a marble fireplace at the end. A twenty-seven-foot-long elliptical mahogany table with seating for about 25 dominates the room. The Chair, Jerome Powell, enters from a door leading directly from his office, and sits at the center. Members of the Board of Governors, each appointed by the President and confirmed by the Senate and having a permanent vote on rate decisions, are said sit to his left: Philip Jefferson, Michael Barr, Michelle Bowman, Lisa Cook, Adriana Kugler, and Christopher Waller. To his right is the Committee’s secretary or deputy secretary followed by the president of the Federal Reserve Bank of New York, John Williams. The other reserve bank presidents from Richmond, Boston, Cleveland, Chicago, Atlanta, St. Louis, San Francisco and Kansas City sit around the ends of the table and key staff sit across from the Chair.

Federal Reserve Staffing and Budget

The Board, together with the regional banks and the five Board advisory councils, employ a total of 23,895 staff, including their own police force. Only about 3,000 people on the direct Board of Governors staff are considered federal government employees. The rest are not civil service employees but work for their respective reserve banks; they continue normal operations if the government shuts down.  The Fed is set up to be self-funded; its earnings from asset holdings and fees charged to banks are used to pay approximately $6.3 billion of annual expenses, with the remainder of all earnings turned over to the U.S. Treasury. However, since September of 2022, for the first time in history, they have not been able to cover operating costs. In effect, the Fed sends an IOU to the U.S. Treasury for the difference, which now amounts to $156.2 billion.

Federal Open Market Committee Meetings

Despite the big budget shortfall, Fed operations have continued without interruption. Over the course of a two-day FOMC session, various members of the staff including legal counsel, economists, researchers, statisticians, systems operators, regulators and special advisers, may attend and make presentations. After administrative matters are dispensed with, the manager of the System Open Market Account, Roberto Perli, typically presents a summary of developments since the last meeting. This report is followed by discussions of expectations for monetary policy. There may be a briefing on a special topic. Then staff present summaries on the status and outlook for the U.S. and global economies, and strengths and vulnerabilities in the U.S. financial system. Each quarter, there is a summary of economic projections and chart of where FOMC voters see rates moving this year and, in the years, ahead. Members then participate in a go-round in which they express views on current conditions, outlooks, financial stability, risks, appropriate monetary policy actions and anticipated financial market reactions.  The Chair distills these views, forges agreement, and seeks approval not only of the specific policy directives but also the careful wording in the Committee statement to be released at 2:00 p.m.  The meeting on the second day typically begins at 9 a.m. and concludes by 10:30.

Dot Plot First Released in 2012

The FOMC holds eight regular meetings each year. In 2020, there were two unscheduled meetings held in March, one by videoconference on a Sunday morning, and four “notation” votes in which ballots were cast electronically. In the past, the workings of the policymakers were quite mysterious. Before 1994, the public was not even informed of the Fed’s rate decision until the minutes were published weeks later; traders had to look to the actions of the New York Fed’s trading desk for clues on any policy changes. In 1995, statements began to include the target rate for the first time. In 2000, the FOMC decided to make a statement after each meeting even if no changes were made. One year later, the full public statement was discussed even before members took a vote on policy. Beginning in late 2004, minutes were released three weeks after each meeting. The first quarterly summaries of economic projections were published in November 2007 and the infamous “dot plot” made its first appearance in 2012.

FOMC Holds the World’s Attention

The dot plot was the center of attention on Wednesday afternoon with most traders expecting it to show the median projected cut for this year at 75 basis points.  Investors poured through the statement and summary, searching for clues on the timing of any tapering of quantitative tightening. Opinion in advance of the meeting was nearly unanimous that the Fed would hold rates steady through May and that Fed concerns would focus on upside inflation risks. There are some who sense that Chair Powell is actually more concerned about the economy than the capital markets. The FOMC meeting was the major economic event in March, even coming in the context of a heavy Treasury auction schedule, central bank meetings in Japan, China, and 6 other nations, key economic data on jobs, housing, inflation, manufacturing and retail sales, threatened government shutdowns, impeachment hearings, and major court cases. The next meetings are scheduled forty days from now: April 30 to May 1.

Long-term Tax-exempt Yields are Below Historical Averages Going Back to 1917

In the municipal market, it is still a seller’s market with a significant supply/demand imbalance. Municipal bondholders will have received $30.5 billion of principal and interest payments by March 31 but the visible supply only totals $7.05 billion. Muni/Treasury ratios are at historic lows, however, and investors are being drawn to the record volume of corporate bonds being sold, a stock market that keeps rising around all things AI-related, and a 47% jump in Bitcoin prices since the start of the year. Institutions, mutual funds in particular, have stepped up tax-exempt purchases; net flows into conventional mutual funds exceed $10.4 billion in 2024. This has offset some of the decline in bank and insurance company participation. Retail is still the backbone of the market, although purchases typically drop off in the run up to Tax Day and there is that constant siren cry from the stock market creating a frenzied Fear of Missing Out on, for example, the 86% gains seen in Nvidia stock prices.  A record level of cash — $6.1 trillion — sits in money market funds waiting to be deployed: $120 billion in tax-exempt funds, $4.97 trillion in government funds. Nevertheless, long term muni issuance exceeds $82 billion this year, up 30% from 2023, and primary sales have been exceptionally strong with frequent repricing’s to lower rates.  The absolute yields for investors are attractive while long-term tax-exempt yields for borrowers remain below historical averages going back to 1917, according to Municipal Market Analytics data. Municipal bonds are basically flying out the door; primary dealer holdings of tax-exempts at $3 billion is the lowest amount ever recorded. And, with respect to returns, the high yield sector, including non-rated bonds, stands out this year.  The ICE BofAML high yield muni index is up 2.38%, outperforming investment grade indices at negative 0.06%.

Bond Sales This Week

This week, investment grade corporate bond issuance exceeded $24.8 billion ahead of the FOMC announcement. Year-to-date high yield corporate issuance at $70.7 billion is up by 82% over the full first quarter of volume in 2023. In the tax-exempt market, $6.5 billion of bond sales are planned this week, including $108.8 million of Wisconsin Health and Education Authority revenue bonds for BBB-minus rated Three Pillars Senior Living Communities, $349 million of non-rated Suffolk Regional Off-Track Betting Corporation bonds, and $26.9 million of non-rated general obligation bonds from the Olney Hamilton Hospital District in Texas. Last week, we saw the Idaho Housing and Finance Association come to market with an $8.4 million Aa2 rated state-enhanced bond sale for the K-10 Treasure Valley Classical Academy in Fruitland that was structured with a 2059 final maturity that priced at 4.625% to yield 4.75%. At this writing, on the second day of Spring, the 2-year municipal general obligation bond yield is 2.79%, the 10-year stands at 2.45% and the 30-year benchmark yield is 3.63%. The 2-year Treasury yields 5.40%, the 10-year stands at 4.28% and the 30-year benchmark yield is 4.43%.