“A highly accommodative stance of monetary policy remains appropriate,” Fed chair Janet Yellen said at the start of her press conference. Despite hawkish pressures building, Yellen’s tune did not change.
The Federal Open Market Committee (FOMC) statement on Wednesday was little different from July’s statement. Of note was the change in the characterization of inflation, which is running below the 2 percent target. The CPI reading of 1.7 percent released earlier in the day is a material drop from last month’s reading of 1.9 percent and gives the Fed more room to keep rates low.
But how would the Fed deal with its “considerable time” language from the July statement? This phrase defines the period of time between asset purchases (QE) ending and the first rate hike. The FOMC chose to keep this language known as “forward guidance,” thus putting a dovish slant on their decision.
Data Dependent
Yellen confirmed in her press conference the Fed will use the data it gets from inflation and employment and that there is “no fixed mechanical interpretation of a time period” for the “considerable time” phrase.
The two dissenters in the voting process were Dallas Fed president Richard Fisher and Philadelphia Fed president Charles Plosser who think that the time to normalize policy should be sooner than what is implied by “considerable time.”
The “significant underutilization of labor resources” phrase was also kept. “The labor market has yet to fully recover,” Yellen said.
Inflation Key
PIMCO CIO Bill Gross commented on CNBC that inflation and inflation expectations will be the main driver for future decisions. He characterized the U.S. economy as being “closer to disinflation than inflation.”
All in all, the U.S. economy is recovering and looks to be on a brighter path than other major economies. The latest readings are encouraging with 4.2 percent second quarter GDP, 6.1 percent unemployment rate, but with inflation at 1.7 percent. Long-term inflation expectations remain well anchored.
Asset purchases were further reduced by $10 billion per month. So going forward, the Fed will purchase $5 billion per month of agency mortgage-backed securities and $10 billion per month of longer-term Treasurys. The asset purchases are expected to end after the October FOMC meeting.
Yellen also discussed that real GDP was running at 1 percent in the first half of the year. As part of the summary of economic projections, growth was downgraded for 2015 to 2.6 percent to 3.0 percent from 3.0 percent to 3.2 percent in June. Unemployment is seen as moving lower.
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‘Dot Plot’
The September meeting provided a new “dot plot“—FOMC participants’ projections of the target federal funds interest rate at the end of 2014, 2015, 2016, 2017, and in the long run. It reflects the path of fed funds that each participant thinks is most likely.
The comparison with the June dot plot can give some insight into how participants’ view on the path of interest rates has changed. It is slightly more hawkish than in June.
For example, in June, fed funds were projected to rise to 1 percent by the end of 2015 (median of participants’ projections) and 2.5 percent by the end of 2016. Now, 1.125 percent is projected by the end of 2015 rising to 2.875 percent by the end of 2016. At the margin, this reflects a slightly faster pace of rate hikes.
The longer run level remained at 3.75 percent. The first rate hike is expected to take place in mid-2015. In terms of market expectations, futures prices indicated a slower pace of rate hikes with some commentators theorizing that Yellen’s own projections are lower than the median.
In principle, the pace of rate increases and its terminal rate are more critical than the date of the first rate hike. The U.S. Treasury curve flattened slightly in reaction as short-term yields rose more than long-term yields.
Market Reaction
The Dow reached another record high prior to the Fed and the S&P 500 climbed back over 2,000. The ever-strengthening U.S. dollar hit a six-year high against the Japanese Yen, surpassing the 108 mark.
The Fed’s monetary policy is looking increasingly in sharp contrast to that of the European Central Bank, Bank of Japan, and now also the People’s Bank of China, which began providing liquidity to its top banks on Sept. 16.
The FOMC next meets on Oct. 28-29. A new summary of economic projections and a press conference with Yellen will take place with the Dec. 16-17 meeting.
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Rahul Vaidyanath is a Chartered Financial Analyst (CFA) with 15 years of capital markets experience. He has worked in the Financial Markets Department at the Bank of Canada as Principal Trader, Foreign Reserves Management. He has also worked as a mortgage bond trader in the U.S. Follow him on Twitter @RV_ETBiz.
