Market response to the September FOMC - Westpac

Richard Franulovich, Research Analyst at Westpac, notes that the FOMC left policy unchanged, the statement and Chair Yellen though made clear that the “case for an interest rate increase has strengthened”, without committing to a specific meeting, while the dot plot shifted in a dovish direction throughout the forecast period.

Key Quotes

“In summary, a hawkish hold in the statement and a dovish set of dots.

·         The Fed made several key changes to its statement, all in a slightly more hawkish/constructive direction. The Fed now explicitly notes that, "Near-term risks to the economic outlook appear roughly balanced," a characterisation the Fed has eschewed from making for some time. That replaces, "near term risks have diminished."

·         The statement also inserted a fresh line indicating the possibility of a rate increase, borrowing from Chair Yellen’s Jackson Hole speech, “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.” This is entirely sensible, keeping the case for a December hike firmly on the table without fully committing to it.

·         There were three dissenters who favoured a hike – George, Mester and surprisingly, Rosengren.

·         The assessment of current conditions saw only cosmetic changes - the Fed describes the labour market as continuing to “strengthen” and notes that activity has “picked up from the modest pace seen in the first half of this year”.

·         The dot plot showed the highly anticipated dovish tilt. For 2016 the median dot is at 1 hike, down from 2. That was always going to happen given there remains just one meeting this year where the Fed could feasibly lift rates – 14 Dec. Their next meeting, 2 Nov, is compromised by the presidential election a week later and in any case there is no press conference or fresh projections to help communicate a potential hike. There are three dots in favour of no change in rates this year, one might argue Bullard, Brainard, Tarullo or Evans based on recent commentary. That makes for quite a diversity of opinion - 3 favouring no hikes this year and 3 favouring a hike today.

·         As for 2017, the median favours 2 hikes, down from 3, while the 2018 median is unchanged at 3 hikes. The more dovish bias is clear to see when 2016 and 2017 are combined. Back in June the median dot showed 5 hikes through to end 2017 (2 in 2016 and 3 in 2017). Three months later the revised dot plot shows 3 hikes to end 2017 (1 in 21016 and 2 in 2017). The long run neutral rate fell 12.5bp to 2.875%.

Market implications

·         With market pricing for a 14 Dec hike already hovering at a relatively elevated 55-60% probability for some time there is not a heck of a lot of fresh potential interest rate support to fuel a meaningful leg up in the USD.

·         We do not feel that the USD has the wherewithal to make a more concerted run higher in the next few weeks - the ECB does not appear to be in any rush to extend QE, our US data surprise index remains a fair distance from hitting rock bottom levels while the FOMC is unlikely to deliver anything more than a very “dovish” December hike.”