Appropriate policy but highlighting downside risks

Fed repeats 'current stance of monetary policy is appropriate'

As expected, the Fed did not change its Fed funds target rate (still 1.50-1.75%) sticking to its message that 'the current stance of monetary policy is appropriate'. The biggest changes to the statement were that it now says that private consumption is growing at a 'moderate pace ' (previously 'strong pace') and that the Fed expects inflation to 'return ' to the symmetric 2% target. During the press conference, Fed chair Powell stated that the labour market could tighten further, i.e. the solid jobs report is not enough for the Fed to start hiking interest rates. On the corona virus, Fed chair Powell said the Federal Reserve is monitoring the situation closely and that the size of the macroeconomic impact is uncertain. He also said that the Fed expects a global rebound but that it is not given and that the corona virus is a new downside risk to this expectation .

While there was no market reaction to the policy announcement, investors interpreted Fed chair Powell dovishly and US 2Y yields dropped 3bp during the press conference. The statement was neutral but Powell highlighted some downside factors during the press conference. Investors are pricing in slightly more than one and a half cut by year-end. Our base case is another cut this year, probably as early as this spring, although it is not a high conviction call.

The Fed's decision last night proved relatively uneventful for USD despite the soft hints lifting EUR/USD a tad. The cross has so far failed to make a sustained break of 1.10, but in the absence of Fed interest in near-term easing and in light of only minimal signs of euro area growth pickup, risks remain on the downside for the cross in our view. If the BoE cuts today, the GBP may drag the EUR down with it against the USD and bring a firm break of the 1.10 mark (support likely at 1.1081, 29 November 2019 low).

On the monetary policy strategy review, Fed chair Powell repeated the Fed's ambition to conclude the review in the middle of 2020. This means an adoption of a new policy regime, most likely shifting to an average inflation target (i.e. inflation needs to be 2% on average over e.g. five years), can be taken in the second half of 2020.

On the liquidity situation, the Fed raised the interest rate on excess reserve (IOER) by 5bp to 1.60% from 1.55% (and O/N RRP rate to 1.50% from 1.45%), as we had expected . The reason is that the effective Fed funds rate has been trading at 1.55% lately and the Fed prefers the Fed funds rate closer to the mid of the target range, i.e. 1.625%. The Fed also extended repo operations to 'at least through April ' and repeated that T-bill purchases continue into the second quarter. Fed chair Powell said during the press conference that the Fed wants to keep reserves above USD1,500bn.

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