Trading the FOMC
The FOMC Policy Statement for September 2016
For release at 2:00 p.m. EDT
Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year. Although the unemployment rate is little changed in recent months, job gains have been solid, on average. Household spending has been growing strongly but business fixed investment has remained soft. Inflation has continued to run below the Committee's 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.
Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.
In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.
Markets Post-FOMC: Views From Major Banks
Danske (out of consensus): We Stick To Our Call For No Fed Hikes This Year
Although the more hawkish statement puts pressure on our Fed call, we stick to our view that the Fed will not hike this year, especially as we think the Fed may be too optimistic about the current economic situation given the weakness in ISM and retail sales, but it is a close call. We have outlined our view in Presentation US: 10 reasons why we believe the Fed will not hike this year, 14 September. However, incoming data will be analysed thoroughly in coming months and we may see markets react more to positive/negative data surprises. Also, in our view, one should not be fooled about the Fed’s eagerness to hike as the Fed has communicated an upcoming rate hike the whole year. We still think most voting FOMC members have a dovish-to-neutral stance on monetary policy and when it comes right down to it they would rather postpone the second hike than hike prematurely. It is also worth noting that three voting hawks (George, Mester, Rosengren) all lose their voting rights next year. Markets have priced a 60% probability of a hike by year-end.
Credit Agricole: Fed To Hike In December
The FOMC, as widely expected, opted for unchanged policy at its September meeting with the Fed funds target range maintained at 0.25% to 0.50%. Market participants saw a relatively low probability for a rate hike with policymakers split over the near-term rate normalization path. We look for the FOMC to hike the Fed funds rate by 25 bps on 14- December. Chair Yellen’s comment that the case for a rate hike has strengthened was echoed in the statement. Moreover, the FOMC noted that the “near-term risks to the economic outlook appear roughly balanced.”. The FOMC wants to “wait for further evidence of continued progress toward its objectives.” We expect real GDP growth to average over 2.5% in the second half of the year. As more evidence accumulates that the economy continues to grow above its potential rate and labor markets strengthen further with a likely acceleration in wage growth, we believe that the cautious members of the FOMC will feel more confident about meeting their policy objectives and raise rates. The FOMC continues to expect that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate. The Fed’s updated dot plot put the median Fed funds projection for yearend 2016 at 0.625% and the projected rate hikes for 2017 were trimmed to 2 from 3. The longer run rate was moved down to 2.875%.
CIBC: Fed To Hike In December.
A string of weak data releases in the lead up to today's announcement likely removed any chance of a Fed rate hike. So it comes as no surprise then that the FOMC decided to keep interest rates unchanged at their September meeting. That said, with three officials dissenting, it appears that odds are starting to tilt in favour of a rate hike. The assessment of the economy contained in the statement appears to be little changed from the previous one and a sentence indicating that the case for a rate increase has strengthened was added. Together, those factors suggest that the recent spate of soft economic releases are likely viewed as more transitory than not. While the statement and dissenters argue for more near-term hawkishness from the central bank than had been expected, the SEP favours a longer-term dovish view of the economy. The median of members now only sees two rate hikes next year, while the forecast for the longer-run neutral rate came down a tick to 2.9%. We continue to view December as the most likely timing for the next rate hike, although that's contingent on a rebound in economic data. Overall, while the statement and dissents were more hawkish than expected, the dovishness contained in the SEP appear to be driving markets
Barclays: The committee More Split Than It Has Been At Any Time In Our Memory
Although we had expected a interest rate hike at this meeting, the non-hike was very close call. The language in the statement suggests that the committee was quite undecided in its view. More clearly, with three members dissenting against the decision and three, presumably different, members calling for no further rate hikes this year, the committee is more split than it has been at any time in our memory. This split in views will make FOMC communication and action increasingly difficult this year. In particular, we believe that this level of dissent will make it difficult for the committee to keep the possibility of December rate hike live in the minds of market participants and, indeed, households and businesses.
SEB: The Fed Paving The Way For December Hike
As expected the Fed decided to hold the target range for the federal funds rate unchanged at the policy meeting that concluded today. Disappointing economic data notwithstanding, the no-hike decision came with a hawkish twist as policymakers strongly suggested that rates will be lifted before long. While the case for a rate increase had strengthened according to the statement, the committee decided for the time being to wait for further evidence of continued progress towards its objectives. Every word is there for a reason and “for the time being” is clearly suggesting that the rate hike is close. The balance of risk assessment made a comeback too; near-term risks to the outlook now appear roughly balanced thus also paving the way for a 2016 hike. In addition to that, the new forecasts show a 2016 hike so all of the above is suggesting that the December meeting is in the spotlight. Not only is the election will be out of the way by then but the as opposed to November the December meeting has a press conference attached to it. The committee was unusually split with George, Mester and Rosengren dissenting in favor of a hike while three officials see no rate hike in 2016. What the latter is suggesting, however, is that a huge majority is expecting a 2016 hike since 17 officials submitted forecasts. As an aside, if memory serves us correctly not too long ago Rosegren was a dovish dissenter.
Nordea: Hawkish Signal For December
Today’s FOMC statement and the new dot plot reinforce our expectation that the Fed will hike rates again in December. We continue to believe that a Fed move at the next FOMC meeting in early November is rather unlikely, just one week ahead on the presidential election on 8 November. The renewed downward revision of the Fed’s estimate of the neutral rate adds to the downside risks surrounding our forecast of 3 Fed rates hikes in 2017.
ANZ: Positive For Risky Assets
The FOMC left interest rates unchanged as expected, but signalled that one increase in the Fed funds rate was likely by December. Three voters dissented on the decision to hold rates. Owing to weak growth in the first half of this year, the 2016 GDP forecast was cut to 1.8% and the FOMC now anticipates two hikes in 2017. The gradual approach to raising interest rates and prospect of only modest rises in the future against the backdrop of moderate growth and well contained inflation continues to provide a positive framework for risky assets. Accompanied by exceptionally loose monetary policy in other developed economies, Asia/Pacific markets should continue to be attractive to overseas investors especially given the improving growth backdrop in the region.
BofA Merrill: Fed Signals December Hike; Limited USD Downside
The FOMC clearly signaled a hike before the end of the year in both the language and the dots. The Fed made two important changes to the statement. First, the committee noted that near-term risks to the economic outlook "appear roughly balanced". This is an important step for the Fed to justify hiking rates at an upcoming meeting and is a page out of the playbook from last year. We expected the Fed to make this language change. Second, the FOMC noted that "the Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of further progress toward its objectives." This is a strong signal that the Fed is planning to hike in an upcoming meeting. It is not explicit calendar guidance, but it is a small step in that direction. USD: What's Next? The dollar was mixed in the wake of the FOMC statement. Cross-currents in the statement between three voters dissenting in favor of hikes combined risks to the outlook now being seen as nearly balanced were offset by downward revisions to the 2016-2018 dot plots. On balance, as we expected, today's meeting set the stage for a December hike, which will keep the USD supported (and downside limited)..
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Views From 15 Major Banks
BNPP (out-of-consensus): FOMC To Announce A Dovish Hike; Mkt Short USD Into FOMC
Our economists continue to forecast the Fed delivering a 25bp ‘dovish’ hike, cushioning its delivery with reassurances about gradual tightening going forward. However, even a ‘dovish’ hike would show the market that the Fed are willing to tighten even when very little is priced in and hence the premium attached to all upcoming meetings would need to re-price higher. With the market short the USD, we expect to see a significant strengthening of the USD if the Fed delivers. If the Fed does elect to leave policy unchanged, the USD is likely to take a leg lower with AUDUSD attempting to test 0.7650 and EURUSD 1.1250. However, we would expect the accompanying message to keep a December hike in play (currently priced at 55%%) and hence we would not expect the USD sell-off to extend too far after the initial adjustment.
Barclays (out-of-consensus): The Time Has Come For A Fed 's Hike
The time has come The long-awaited September FOMC meeting has finally arrived, and we retain our call for a rate hike on Wednesday. Mixed economic data last week, including disappointing retail sales amid a solidifying CPI, coupled with dovish commentary by Board members Brainard and Tarullo, have reduced market expectations of a hike, with a 20% probability priced in. We see the likelihood of a hike as higher than market pricing, and there is scope for material USD strength if the Fed delivers. If the committee instead stays on hold, more hawkish members will need to be placated with stronger language that points to a December rate increase. We would expect limited USD potential downside if this is the case. The market will also pay attention to the FOMC's Summary of Economic Projections. We foresee a 25-50bp decline to the appropriate policy path, the ‘‘dot plot’’. We think the median member sees conditions as likely to support only one hike this year, and the appropriate policy path is likely to decrease by 25bp in parallel in 2017 and 2018. Given the very shallow rate path already priced in, the downward revisions should not have a meaningful effect, in our view. Finally, we expect a 25bp shift down in the long-term fed.
BTMU: No Urgency For A Fed Hike; Downside Risk For USD S/T.
With the probability of a rate hike so low, we fail to see the urgency in Yellen going in circumstances of causing a disruption to financial market conditions when we are now within two months of a presidential election...We also find it hard to envisage a “hawkish hold” this evening given the DOTS are likely to be cut for this year and next year and with the long-run fed funds rate probably coming down from 3.00%. Sure Yellen will signal a December rate hike with one DOT for 2016, but will the market believe it? We see downside risks for the dollar over the short-term.
Credit Agricole: No Change; USD Tends To Weaken Post-FOMC But This Time Is Different
We expect no change in policy from the FOMC but we see the September meeting as setting the stage for a rate increase in December. The market is going into the event with a 20% chance of a hike priced in - higher than any of the previous meetings this year but still too low in absolute terms for the Fed to hike without fearing that the move will significantly surprise the markets, triggering some undesired volatility and a tightening in financial conditions. Amid conflicting messages from Fed officials, our economists argue that while the Fed is closer to a hike, there is not enough consensus in the committee to move in September given that there has been relatively little additional progress on inflation since the July meeting. The USD has weakened after every FOMC meeting this year but we believe this time may be different. Market-implied probability of a hike by year-end stands at around 55% - a more hawkish Fed statement should push these expectations higher even acknowledging the risks surrounding the November presidential elections. Any downward revision to the terminal Fed funds rate raises questions about the dollar’s long-term performance but we don’t believe it will hurt the greenback much in the near-term given the flatness of the front-end of the US yield curve. That is, near-term hike expectations should sustainably lift the US 2Y yield, increasing the dollar’s yield advantage. After a long period of disappointment with bullish USD strategies market positioning is not particularly long dollars, which should play into the greenback’s advantage, at least in the near-term.
SocGen: Pricing December Hike With Conviction; USD positive.
The short-term key to yield differentials comes with today’s FOMC announcement. we think it’s now consensual (a few outliers notwithstanding) that the FOMC will encourage the market to price in a December hike with more conviction, which in turn ‘ought’ to underpin US rates/yields and be at least a little dollar supportive.
Lloyds: On Hold; Dot Plot To Point To December Hike.
Markets currently attach only a 20% probability to a tightening in US monetary policy at this week’s policy meeting. Of more interest is what signals are sent about the Fed’s policy intentions for the rest of this year. Most FOMC members will probably want to indicate markets are paying insufficient attention to the risk of a rate rise. The ‘dot plot’ of policymakers’ interest rate predictions will likely show the majority expecting a rate rise in December. The message may be a tempered, however, by a minority forecast of unchanged interest rates.The low probability markets place on a near-term rate hike leaves the risks to the US dollar and Treasury yields tilted to the upside.
Goldman Sachs: Probability Of A Fed Hike Less Than 5%
Later today will bring the much-awaited September FOMC, in something of a one-two punch of central banks. Our US economists put the chance of a hike at less than 5 percent, but see the cumulative odds of a hike by December at 65 percent, basically in line with what interest rate futures are pricing. As a result, they expect a hawkish pause, with the “nearly balanced” language perhaps making a comeback. They expect the dots to show fewer hikes, with the median dot going from two to one for 2016 and from three to two in 2017, i.e. two less hikes through 2018. However, they expect the long run median dot to remain at three percent.
Credit Suisse: FOMC On Hold; Recent USD Strength Perplexing.
The market and policy context of this latest bout of USD strength is particularly perplexing as it follows a highly anticipated and remarkably dovish speech by Fed Governor Brainard ahead of the upcoming 21 September Fed meeting. The unwind of the buildup in hawkish expectations triggered by the speech had a remarkably short-lived impact, as it did not prevent US rates from selling off in line with the rest of G3 (Figure 3). Our US economists expect the Fed to remain at the upcoming meeting.
BofA Merrill: Fed To Send Conditional Hints Of Upcoming Hike; Mildly USD Positive
The "cautiously hawkish" tone that we expect from the FOMC meeting is likely to be mildly USD-supportive, but we doubt it is the start of a new trend. An upbeat economic assessment and nearly-balanced economic risks would support market pricing for a December hike, limiting USD downside, in our view. However, with the market pricing just over one hike between now and end-2017, we believe a necessary condition for the USD to rally is a consistent pattern of better US data allowing the market to price a meaningful pace of hikes in 2017 and 2018. Until then, the USD is likely to be range bound. That said, a residual expectation for Fed hikes is likely enough to limit significant USD downside given most G10 central banks are easing, but the dollar is unlikely to rally either.Additionally, the recent shift by our US Rates Team's to a short real rates stance also suggests USD risks are more on the upside than the downside. The USD has benefitted over the past week as US real yields have risen between 6 and 18 basis points, driving a steepening of the rates curve. While the USD is typically negatively correlated with the shape of the yield curve, it has rallied because the curve steepening has been driven by real yields a relationship we have highlighted on many occasions. Should a real rate-led steepening of the curve continue, we would expect the USD to benefit. Indeed, the dollar continues to look undervalued relative to real yield differentials as we have noted recently.
RBS: FOMC On Hold; No Strong Directional Conviction
Recent soft economic data has made the FOMC meeting less of an anticipated event, but the statement, dot plot, and Yellen’s post-meeting press conference will still be scoured for clues as to how strong the Fed’s desire is to raise interest rates later this year. Our baseline scenario for the FOMC decision is consistent with current market pricing, and thus we do not have strong directional conviction from that event.
JP Morgan: Next Hike In December; USD Unlikely To Fall On Any Dot Plot Drop.
With respect to the FOMC, we continue to look for the next hike in December. While recent rhetoric has increased our confidence they won’t hike in September, it has left our confidence in December unchanged. Firmer inflation data would obviously make us feel better about that call. We will also look to next week’s dots for a sense of how the Committee is feeling about the outlook. In June every participant was anticipating at least one hike this year. We would not be surprised if that changes and there were at least one participant next week anticipating zero hikes. Recall that the dollar has always fallen and bonds rallied after an FOMC press conference when the Committee lowers the dots, but the magnitude and duration of those move have always depended on the global context. In an environment where US activity data looks stable on average and where most inflation measures are moving higher, we doubt that another dot drop would weaken the dollar much.
RBC: Relatively Unremarkable; A Dovish Hold
There is a widespread expectation that the outcome of today’s meeting will be a “hawkish hold”. We think the risk is the tone of the press conference and revised forecasts fall short of expectations. Our economists think the statement itself should prove to be relatively unremarkable, although a modest downward tilt to the characterisation of the economic backdrop is likely in the offing. They think the dots will shift lower, reflecting the removal of another hike this year, although the committee is likely to keep the “optionality” of a 2016 increase alive. Yellen’s press conference should lean on the dovish side given the recent bout of soft economic numbers.
ANZ: FOMC On Hold; Dot Plot To Be Revised Down
For the FOMC, expectations are that rates will be kept on hold. Whilst levels of resource utilisation in the labour market could justify a rate rise, headline inflation remains significantly below target and activity readings on the economy have been at best patchy recently. Central case expectations are that the dot points will be cut by 25bps and the FOMC will maintain its optionality by leaving one rate hike in for December. If the FOMC maintains its view of three hikes next year and in 2018 that would automatically lead to a reduction in the median estimates of fed funds for those years. Following the disappointing growth outturn in the first half of this year, there are downside risks to this year’s growth forecast (currently 2.0%). Forecasts for 2019 will also be published.
Nomura: FOMC On Hold; Next Hike In December.
We do not expect the FOMC to change policy this week. FOMC participants continue to stress that their policy decisions are “data dependent.” The economy’s performance in the first half of the year was relatively weak. There is some evidence of a pickup in recent months, but the latest data suggest that activity slowed at the end of the summer. We think the FOMC will need to see a more sustained acceleration of economic activity before raising rates again. That said, many FOMC participants, including Chair Yellen, have argued that “the case for an increase in the federal funds rate has strengthened in recent months.” Given these comments, we cannot rule out a rate increase this week. Based on our forecasts for growth of a little above 2 percent in the second half of the year, we expect the FOMC to raise its targets for short-term interest rates in December. The FOMC forecasts for 2016 are likely to be changed somewhat to reflect the data that have been released since June. But beyond these basic changes, we do not expect major changes to the FOMC’s economic forecasts. We expect many FOMC participants to lower their forecasts for interest rates. A number of FOMC participants have said that they now expect interest rates to stay lower for longer. In effect, they have lowered their expected path for the “neutral” interest rate.
NAB: No Change Expected But Two Dissenters Likely.
The US FOMC announces their rate decision Wednesday along with the Fed Chair’s press conference and the FOMC’s latest forecasts of growth and inflation. Given recent speeches by Fed officials, we wouldn’t be surprised to see two dissenters in a no change decision – those being George and Mester with Rosengren also a possible dissenter. Despite the likelihood of dissenters, the majority of the FOMC remain cautious in changing rates and the recent soft data flow will likely reinforce that approach. Aside from the decision itself, the focus will be on the Fed’s latest forecasts for growth, inflation and the Fed Funds rate in their “dot plots” as well as Fed Chair Yellen’s post-FOMC press conference.
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