December FOMC Meeting

First in a decade

Seven years (to the date) after moving to the zero lower bound, the FOMC voted unanimously yesterday evening to raise its rate target by 25bp, in a dovish statement. Janet Yellen underlined that the path of policy tightening is likely to be gradual and will depend on how economic data (unemployment, Inflation and GDP) and the outlook evolve.

Hence, in order to support the ongoing progress towards maximum employment, price stability and growth, the Committee decided to engineer a “dovish hike”:

• Funds rate – upper bound: from 0.25 to 0.50%
• Funds rate – lower bound: from 0 to 0.25%
• Discount rate: from 0.75 to 1%

The median fed funds rate projection (dot plot) was unchanged at 1.375% for 2016, implying four quarter-point increases in the target range next year, based on the median number supplied by 17 officials. Nevertheless, the median member predicted one hike fewer in 2017 and and a ½ hike less for 2018.

The committee's current reinvestment policy on its holdings of Agency MBS and Treasury securities was maintained and is unlikely to change “until rate normalization is well under way”.

Economy:

• Unemployment: In its statement, the FOMC saw further improvement in the labor market, and characterized the risks to economic-activity and labor-market outlook as “balanced”, noting that “labor-market indicators will continue to strengthen”. “The Committee judges that there has been considerable improvement in labor market conditions this year” and less concern about its evolution for the year to come.
• Inflation: Global uncertainties contributed to the appreciation of the dollar, lower energy prices and lower commodity prices, leading to further downward pressure on inflation. Acknowledging that inflation has been falling short of expectations, the Committee will “carefully monitor” progress toward its 2% inflation target.
• GDP: Recent turmoil in emerging markets, coupled with slow European growth, should not weigh on the US economy. The view of current economic conditions was little changed, with both household spending and business fixed investment still seen as increasing at a solid pace.

 

The FED has effectively met its employment and GDP mandate. The underperformance in FED inflation reflects the impact of the lower commodity prices and stronger dollar. However, the continuing labor market improvement should reinforce the FED’s forecast of inflation returning towards target in the medium term.

Market impact

FED measures

The verbal assurances contained in the FOMC statement and in J. Yellen’s conference succeed in implementing of a ‘dovish hike’. Still, although the reaction of the US Treasuries curve was not very pronounced beyond the initial volatility, the curve has stayed flatter as 10y yields are back at their pre-FOMC levels of 2.26% while 2y yields have breached the symbolic 1%.

  

Money Market Investment strategy

This meeting confirms that monetary policy accommodation will come to an end. Our funds are oriented in this direction to outperform our benchmark under such market conditions:

• We are maintaining a very low rate sensitivity (25 days) and credit duration (135 days).
• Optimal duration allocation on shorter maturities.
• We favor higher-rating names that will generate low volatility in our fund 

Pierre Boyer
Head of Money Market Fund Management