FOMC statement soothes hawks

End of QE-3 programme

More upbeat tone on the labour market: undertilization of labor resources diminishes

Not too concerned about risk of too low inflation

Tweak in forward guidance: considerable time stays, but lift-off is fully datadependant

Fed hawks Fisher and Plosser drop dissent, but now dove Kocherlakota dissents

Curve bear flattens, dollar gains, while equities digest statement well

FOMC shifts towards hawkish side

The outcome of the FOMC was definitely more hawkish than most analysts had expected on various points and suggests that the normalization will continue. The end of its QE‐3 programme was widely discounted. However, more surprisingly, the FOMC was more upbeat on the labour market, while they could have expressed more concern about inflation than they effectively did. Finally, they tweaked their forward guidance. They still anticipate “that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month”. But they added for the first time that the timing of the lift‐off is totally data‐dependant. So, de facto the considerable period of time phrase has little particular meaning anymore. This, of course, doesn’t necessarily mean that the lift‐off will come faster than previously thought.
However, combined with their greater optimism on the labour market, one cannot but conclude that the Committee shifted to the more hawkish side. Not enough to drop the considerable time phrase altogether, but enough to take a further step towards the normalization of policy. We expect now that the forward guidance may disappear in one of the next meetings and that the first tightening may occur around mid‐2015, if not slightly earlier.

Tellingly in this respect, the two hawks, Plosser and Fisher, who dissented previously against the FOMC decision/statement now voted in favour, as they were apparently satisfied by the shift the FOMC made. On the contrary, it was now ultra‐dove Kocherlakota who dissented. He wanted to continue QE 3 and pleaded for a commitment to keep rates unchanged “at least until the one‐to‐two‐year ahead inflation outlook has returned to 2 percent”.

Upbeat tone labour market

The statement was on a few points clearly more upbeat than in September (italic is new). Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. Furthermore, on balance, a range of labor market indicators suggests that the underutilization of labor resources is gradually diminishing. The September statement said “..there remains significant underutilization”.

Not too concerned on inflation

The statement mentions Inflation twice. First, the Fed acknowledges (like before) that inflation is below the 2% target. “Inflation has continued to run below the Committee's longer‐run objective.” It then balances the lower market‐based inflation expectations with the stable survey‐based expectations (new): “Market‐based measures of inflation compensation have declined somewhat; surveybased measures of longer‐term inflation expectations have remained stable.”

Second, the FOMC said inflation will remain low short term due to energy prices (is not threatening) and the nonspecified “other factors....” Importantly, they retain the phrase that the likelihood it will persistently run below 2% have diminished somewhat. “...., the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year?”

Given the lower inflation globally, the decline of inflation expectations and the ongoing low US wage growth despite declining and low unemployment, this is a “hawkish” assessment of inflation by the Fed, also because many Fed governors recently pointed to the risks for too low inflation. So, the “hawks” apparently scored on this point. The vote in favour of the statement of Fisher and Plosser, previously dissenters, is telling in this respect.

Forward guidance retained, but....

The text on QE and forward guidance was extensively amended. Regarding QE, this occurred for the obvious reason (end programme). The end of QE should nevertheless be considered as a Fed vote of confidence in the economic outlook. It also suggests that the Fed won’t be too easily influenced by volatility in the riskier asset markets. On forward guidance, the FOMC retained the main phrase: “The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month...” It does so despite their satisfaction about the labour market progress: “The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability” However, by adding the following phrase, they effectively say that they are completely data‐dependant.“ “However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”

Conclusion & market reaction

Concluding, the FOMC took a further “measured” step towards normalization. Their upbeat tone on the labour market combined with downplaying the risk of too low inflation suggests that the moment approaches when they will drop the considerable period of time forward guidance altogether. The FOMC is not in a hurry and takes her time to slowly advance towards the rate lift‐off. Mid‐2015 is certainly still on the table. Markets had recently pushed the timing of the lift‐off towards February 2016. After the statement the December FF contract jumped 8 bps to 0.53%, suggesting now the first rate hike by the end of 2015. If eco data would be strong in the next weeks, the market will have to discount a faster lift‐off.

The market reactions in the FX and rate markets were substantial, but not exceptional. The dollar gained 1 big figure against euro and yen (1.2635 and 108.9 respectively). The US yield curve bear flattened with 5‐year yields up 7.5 bps, but 10‐year yields up a modest 2.5 bps. Equities lost initially modest ground, but erased these losses almost completely. It seems equities appreciate the Fed’s economic optimism about as much as they fear the future higher rates. None of these moves are technically very important. The October payrolls might give the market a better take on the economic outlook and on the timing of the next FOMC step. A strong payrolls report could be a wake‐up call for rates market, relaunch the dollar uptrend, while equities need to contemplate how it assesses a stronger economy with less monetary accommodation.