FOMC meeting: Shifting to a tightening bias

• Fed shift to a clear tightening bias and keep December a “live” FOMC meeting
• Risks from abroad no longer a big concern
• We place the highest odds on a January rate hike as manufacturing weakness is likely to keep Fed on hold in December

The Fed send a clear message in its October FOMC statement: a hike at the December FOMC meeting is a real option and whether we will see the first rate hike in December or next year depend on the data.

In its forward guidance the Fed is now flagging a clear tightening bias as the wording was changed to “In determining whether it will be appropriate to RAISE the target range at its NEXT meeting...” from “In determining HOW LONG to MAINTAIN this target range...” and then the conditions remains unchanged “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 “.

Further, the reference that “Recent global economic and financial developments may restrain economic activity” was removed from the statement which now only says that the FOMC is “monitoring” global financial and economic developments. Hence, the Fed’s assessment is that risks from abroad have abated and there is one hurdle less towards a rate hike.

The statement acknowledge that the pace of job growth has slowed recently but repeats that underutilisation has diminished since early this year. Economic activity is described as “has been” expanding at a moderate pace instead of “is”, which suggest that the Fed is not completely sure about the pace of growth right now and would like to see data that confirm the moderate pace of expansion in coming months.

We continue to place the highest odds on a January rate hike from the Fed as we believe that the weakness in the manufacturing sector will keep the Fed in a wait-and-see mode at the December meeting but that they will use the meeting to prepare markets for a near term rate hike.

Given the tightening bias in tonight’s FOMC statement it seems fair that the market now attaches a higher probability, currently 45% compared to the pre meeting 32%, for a rate hike in December. A more firm pricing of a December rate hike, will require data confirming that the US economy is growing above potential. The next data releases to watch are the Q3 Employment Cost Index released Friday and next week’s October manufacturing ISM release and employment report.