FOMC sends diffuse message

Another $10B taper of the QE programme

No changes in forward guidance, still significant undertilization of labor ressources

Slightly less optimistic on future growth, but

Eye-catching increase in rate projections; 3.75% FF rate projected at end of 2017

Fed specifies exit policy: FF rate (range) remains key rate

Fed Fisher joins governor Plosser in dissenting

The FOMC decided to taper its asset purchase programme by another $10B to $15B a month and specified that if the expected ongoing improvement in the labour market is confirmed it will end its programme at the next meeting.
This was largely expected. However, the message coming from the statement, the rate projections and Yellen’s was confusing and open to multiple interpretations. The Forward guidance (considerable period of time) and the significant underutilization of labour resources was retained unchanged, but at the same time, the projected Fed Fund rate path was substantially shifter higher (and even further away of current market expectations than before).
Additionally, there was one additional dissenter. Chair Yellen tried to downplay the changes in the rate projections, but at the same time downplayed the “considerable period of time” by stressing that the FOMC was completely datedependent and would not be hindered by that “considerable time” phrase if it thought the data necessitate a rate change. The market reaction was modestly hawkish.
The change in dots trumped the unchanged forward guidance and the sober assessment. US Treasuries lost ground; the 5‐year sector hit the most. The dollar gained against the euro and especially the yen. Equities first fell, later rallied, but ultimately closed little changed.

Sober economic assessment

The economic assessment was not fundamentally changed from the one in the July FOMC statement, but at the margin it sounded a tad softer. Economic activity is expanding moderately. Labour market conditions improved somewhat further. The addition of “somewhat” is probably due to take the latest weaker payrolls growth into account. Similarly, the September statement notes that the unemployment rate is little changed (previously: declined further).
Importantly, the statement keeps stating that there remains significant underutilization of labour resources. No changes in the description of household spending (rising moderately) or in business investment (advancing). The sentences on inflation were also at the margin more sober, likely because the two last inflation reports were soft.
Chair Yellen in her comments however sounded at ease with the current economic development and sees a continuation in the next quarter (and years).

Forward guidance unchanged

Markets were focussed on the wording of the forward guidance with many, including us, expecting some change.
That didn’t happen. Yellen was thoroughly questioned on the subject and the meaning of “considerable time” that the Committee expects to keep the Fed Funds target range unchanged after its asset purchases stopped. She said that the Committee still felt comfortable with the sentiment the wording expressed. However, she especially stressed that the Committee was completely data‐depended and would adapt policy if the economic conditions had changed in such a way a change was appropriate. The phrase would not prevent the Committee from doing what was needed at the time it was needed. The sentence wouldn’t tie their hands. It is our feeling that there wasn’t consensus about the way forward guidance should be reformulated, but the statement has very little meaning anymore.. Maybe the Committee felt that markets would read too much in a change and overreact. The subject will no doubt be debated at next meetings and the wording of the forward guidance changed.

One more dissenter

Governor Plosser confirmed its previous dissent with the statement and more particular with the “considerable time” passus, because that’s time dependent an does not reflect the considerable economic progress that has been made towards the FOMC goals. Dallas Fed Fisher this time joined Plosser. Fisher dissented because he thinks economic and financial developments will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee’s forward guidance. Two dissenters shouldn’t be seen as problematic and doesn’t point to a much divided Committee. We think that there is a solid majority supported the current policy of very slowly moving to normalization.

Path rate projection shifts higher

The economic projections didn’t contain significant changes. Growth projections were marginally revised lower, as were unemployment rate projections while inflation projections were slightly revised higher. By mid‐to end of 2016, the projections suggest that full employment (unemployment rate of 5.1 to 5.4%) is reached and inflation is near the 2% target.

As before, the large majority of governors, 14 out of 17, expect the first rate hike in 2015. One governor sees it already in 2014 and 2 (previous 3) in 2016 occurring. More interesting were the projections of the Fed funds rate at the end of 2015, 2016 and 2017 (mid‐point target range). The expected rate path shifted higher and the median projection amounts now to 1.375% (1.125%), 2.875% (2.5%) and 3.75% (first projection). Yellen called it slight changes versus the June projections, a qualification we don’t subscribe. The long run (neutral) rate was unchanged at 3.75%. A few observations should be made. So, while the FOMC expects economic equilibrium by the end of 2016 (or slightly earlier), it expects the equilibrium rate (3.75%) only to be reached by the end of 2017. She invoked the slowly dissipating headwinds after the financial crisis as a possible reason why the Fed governors think they need to hike rates later and slower than in the past and also than most common used monetary policy rules (like the Taylor rule) prescribes. The end 2015 projection of 1.375% is also interesting. To reach it, the FOMC should start raising rates in June 2015 and follow up with a 25 bps hike at each of the remaining 5 meetings. This looks more likely to us than starting in July/August and go in bigger steps. While the June meeting looks possible, we don’t exclude the March (meeting with press conference) or April meeting. Starting somewhat earlier may keep the Fed ahead of the curve and avoid making some bigger or faster moves later on in the cycle. She was also questioned on the huge gap between market expectations about the policy path and the Fed’s projections, but her answer was a bit evasive. The “hawkish” market reaction was likely due to the rate projections.

Policy normalization principles and plans

The FOMC examined and somewhat revised the 2011 statement on normalization principles. The principles were already largely written down in the June FOMC Minutes and thus didn’t contain surprises. The main tool to change policy will remains the target range for Fed Funds rate. During the normalisation, the Fed will adjust the interest rate on excess reserves to move the FF rate into the target range. A supplementary tool to keep the FF rate in its target range is the reverse repo facility. It will use the latter only to the extent necessary and phase it out when no longer needed.

The normalization of the balance sheet will occur only after the FOMC begins increasing the FF target range. The reduction of the securities will be done in a gradual and predictable manner, primarily by ceasing to reinvest repayments of principal on securities held in its portfolio. The Committee currently does not anticipate selling agency mortgage‐backed securities.

Hawkish market reaction

On the Treasury market, the yield curve shifted modestly higher, with the 5‐year, the sector most sensible to an upcoming tightening cycle, hit the hardest. Yields increased by 5.6 bps at the 5‐year, 3 bps at the 2‐year and respectively 2.7 and 0.8 basis points at the 10‐ and 30‐year tenor.
Equities hovered up and down, but closed little changed.
On the FX market, the moves were maybe the strongest.
EUR/USD fell lower with the lows of the current downtrend under test. USD/JPY surged higher not hindered by resistance levels and set new cycle high at 108.85.