Another $10B tapering diminishes asset purchases to $25B/month

Slightly more upbeat on the labour market

Less concerned about too low inflation

No reference to excessive risk taking

No other policy changes and no hints about timing lift-off

Governor Plosser dissents on guidance of maintaining FF rate at current levels for a considerable time after QE ends.


Tapering continues

As expected, the FOMC once more tapered the QE programme by $10B, as it has done at all meetings since December 2013. The justification is the same as before: there is sufficient underlying strength in the economy to support ongoing improvement in labour market conditions. We see no reasons to doubt the programme will be tapered further at the September meeting and end it altogether at the October meeting, even as the FOMC continues to repeat that asset purchases are not on a preset course. The FOMC also keeps its policy of reinvesting of maturing assets.


More upbeat on economy

The FOMC assessment of the economy stated that the economy had "rebounded in the second quarter". “Labour markets improved, with the unemployment rate declining further.” The statement didn’t anymore mention that the unemployment rate “remains elevated”. This is a recognition that the unemployment rate, now 6.1%, is nearing levels closer to its long run equilibrium rate (which the Fed currently puts in the 5.2 to 5.5% range).
However, to keep observers from thinking that it implied that a change in policy was possible in the not so distant future, the FOMC added the following phrase: “However, a range of labor market indicators suggests that there remains significant underutilization of labour resources” More in particular the majority of FOMC members who are in command of setting policy, wants to see wage growth accelerating. Wage growth is now in the vicinity of 2‐2.25% and was in the years before 2007 around 4%. The latter gives healthy real wage growth, needed to support household consumption. There are some early signs of stronger wage growth, but admittedly these are still fragile. We expect wage growth to start accelerating in the fall.


Less concerned on inflation

Recently, inflation has moved higher. Yesterday’s GDP report showed that PCE deflator (and core PCE deflator), the Fed’s favourite gauge of inflation increased to 2% in Q2 from 1.3% in Q1. Also CPI readings rose in recent months. So the statement said: “Inflation has moved somewhat closer to the Committee's longer‐run objective”. In June the FOMC said : “Inflation has been running below the Committee's longer‐run objective”.
Still more important the risks of too low inflation have diminished: The Committee “judges that the likelihood of inflation running persistently below 2% has diminished somewhat” In June the FOMC was more concerned about too low inflation. That’s important as it means that (too low) inflation become less of an argument to keep rates at current levels, even if the labour market would make progress. Indeed, the Fed will take a balanced approach regarding its dual mandate when setting policy.


Forward guidance remains unchanged

First, a highly accommodative stance of monetary policy remains appropriate. Second, “In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress‐‐both realized and expected‐‐toward its objectives of maximum employment and 2% inflation.
This assessment will take into account a wide range of information.......” Third, the Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends. Fourth,”When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer‐run goals of maximum employment and inflation of 2 percent.” Fifth, “The Committee currently anticipates that, even after employment and inflation are near mandate‐consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run”.


Governor Plosser dissents

The dissent at this meeting was not the consensus view, but some, including us, didn’t exclude it either even if many thought that governor Fisher and not governor Plosser would be the dissenter. Both are part of the hawkish aisle inside the FOMC. Fisher had been very vocal on his dissatisfaction with the current policy that according to him didn’t take enough credit for the improvement in the economy. Therefore, he was afraid that policy was too soft and responsible for excessive risk taking. Governor Plosser dissented on the guidance that it likely will be appropriate to maintain the current FF level for a considerable time after QE ends because “such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals”.


Conclusion

The FOMC statement showed that the FOMC is still satisfied with the current policy stance and didn’t find it the appropriate time to signal a policy change in the not so distant future. However, by changing the assessment of labour market conditions and inflation it is clear that gradually the Committee is coming closer to that point.
We suspect that the Committee continued at this meeting to discuss its exit policy. The Minutes of the previous meeting showed that such discussion was ongoing. We will look closely to the Minutes of this meeting to see whether discussions have progressed. Chairwoman Yellen announced that the Committee envisaged publishing a revised exit/normalization plan “later this year”. The dissent of Plosser suggests that the hawks feel that the FOMC may need fasten up the exit given the improvements in the labour market and the rise in inflation. The strong Q2 GDP is certainly an argument in their favour, but the FOMC will need to see further progress (amongst other on wage growth) before effectively starting to tighten policy. The term “considerable time” after QE ends is a centrepiece of the discussions besides many others.


Market reaction subdued

Markets had in the past two months already brought the expected timing of the lift‐off forward to about mid 2015 from the fall of 2015. A further reaction followed on the strong GDP figures yesterday. In this context, the absence of a stronger reaction on the FOMC decision, sometimes even reversing the post GDP moves, shouldn’t be too surprising. In a daily perspective, the curve steepened with the 2‐year up 1.6 basis points to 0.54%. The 5‐year yield rose 8 basis points and the 10‐ year nearly 10 basis points. EUR/USD fell below 1.34 and USD/JPY jumped to 102.80. S&P was nearly flat. The next big item is the payrolls on Friday. Stronger data outcomes may trigger from now bigger market reactions.

This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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