Be steady – change could come relatively soon

As widely expected, the FOMC kept the target range for the federal funds rate unchanged at 1.00-1.25% (no press conference). 

Although the statement remains broadly in line with the previous one in June, there have been some minor changes:

• The more explicit firming in the Committee’s guidance about the timing of the start of its balance-sheet unwind, which they now expect to begin “relatively soon.” “Relatively soon” had not been in the previous statement, but provided that the economy evolves broadly as anticipated.
• At the same time, the FOMC statement did again acknowledge that headline and core inflation have declined. They also acknowledged the further decline in (PCE) inflation since the June meeting, and view inflation as running “below” rather than “somewhat below” their inflation target of 2% in the medium term.
• Elsewhere, the committee upgraded their view on job gains following solid June employment statistics.

What about the market reactions? 

The market appears to have taken a slightly dovish outlook, with the chance of a rate hike in December 17 lowered slightly to 40% versus 45% pre-the FOMC; the 10-year US yields fell by around 4.5bps after the statement and by the same amount on the day. On the FX side, the EUR/USD climbed by 0.7% after the FOMC to a 30-month high. The GBP/USD also climbed a similar amount at the same point: by +0.6%, to a 10-month high.

What’s next?

In this context, our rate expectations remain unchanged, based on the Fed probably announcing it will begin a gradual tapering of its balance-sheet reinvestment purchases relatively soon (September) and we could see the next rate hike in December.

But it’s not a smooth path, indeed doubts remain about the feasibility of the Fed’s plan, because the Fed has also said that both actions are contingent on the current economic and inflation outlook. The recent decline in both headline and core inflation could complicate its task. For now, most FOMC members are still downplaying this movement of inflation away from the 2% target, but if inflation data continue to disappoint the Committee, the doves are likely to gain ground in the coming months ...