FOMC comes gradually closer to lift-off

FOMC provides no clear signal on the timing of lift-off

However, it anticipates it will raise rates when it sees some further improvement in the labour market and is confident inflation will move back to 2%over medium time

FOMC expects moderate expansion of activity and…

Sees additional improvement housing sector and diminished underutilization labour ressources

Decision was unanimously

Market reaction contained: dollar stronger, slightly higher yields and higher equities

The July FOMC meeting was never expected to bring fireworks and the markets got it right. There were no new forecasts and no press conference was scheduled. On top of that, there was only one month of new data since the June 17 meeting. Market activity was shallow due to the holidays, making an, eventual, change in policy difficult to implement without unnecessary volatility. In such context, it is no surprise that the policy rate remained unchanged in the 0‐to‐0.25% range. Nevertheless, while the FOMC provided no clear signal on the timing of the lift‐off, a few hints in the statement clearly suggest that it is gradually moving to the start of its tightening cycle. The September meeting remains our favourite for the lift‐off, but as usual it will depend on the data.

Eco assessment slightly more upbeat

Compared to the June meeting, a few changes suggest that the FOMC saw some further improvement in the economy, notably on the labour and housing market. Overall, activity is still qualified as expanding moderately in recent months. On the labour market, the statement says: “ it continued to improve, with solid job gains and declining unemployment. On balance, a range of labour market indicators suggests that underutilization of labor resources has diminished (somewhat) since early this year.” The word in brackets (somewhat) disappeared in the July statement which is an important positive sign. Second upgrading concerns the housing market, which is now qualified as shown additional improvement, while in June it was qualified as shown some improvement. Growth in household spending was still called moderate, while business fixed investment and net exports were as before called soft.

Inflation still expected to move to target

“Inflation continued to run below the Committee's longerrun objective, partly reflecting earlier declines in energy prices and decreasing prices of non‐energy imports. Marketbased measures of inflation compensation remain low; survey‐based measures of longer‐term inflation expectations have remained stable.” This was identical with the June statement that contained one more sentence on inflation that now disappeared: “Energy prices appear to have stabilized”. Interestingly, we thought the Fed could have shown somewhat more concern about too low inflation as the June inflation data were weaker, inflation expectations were slightly lower and energy prices dropped again which will keep headline inflation lower for longer. The fact the FOMC didn’t show more concern means they think the current and near future inflation figures are transitory and thus less of an item when deliberating on the timing of the lift‐off. They may be seen now more as a positive supply factor than a threat of deflation, as it was seen in H2 of 2014.

One other key change in the statement

“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” Importantly, the word “some” was added to the sentence that was also in the June statement. It suggests that the FOMC doesn’t need to see much more improvement in labour market conditions before starting its rate cycle. This certainly keeps the September meeting a strong contender for a rate increase.

On the other hand, the FOMC called the risks for economic activity and the labour market still “nearly balanced”. There was speculation they would drop the nearly which would have been another argument for a liftoff in the near future.

Finally, the decision was unanimously, even including Mr. Lacker, a renowned hawk. This may suggest that Lacker had the impression that rates would anyway soon be raised, making it superfluous to mark his disagreement with the statement.

Market reactions contained.

The dollar strengthened versus euro (1.1050 to 1.0980) and slightly versus the yen. Equities went a bit higher with daily gains of about 0.7%. Yields moved first slightly lower, later on recouped the losses, but still stayed off the intra‐day highs. In a daily perspective the curve bear steepened with yields modestly up between 1 and 3.6 bps. Fed Fund futures were only very modestly changed. So no bear flattening as one might have been expected and a sign the outcome was indeed near market expectations.