FOMC: steady as she goes

FOMC keeps policy unchanged

The FOMC statement met market expectations that its policy setting would remain unchanged. The Fed prefers to take decisions at meetings where new forecasts are available and a press conference is scheduled. This means March, June, September and December. Given thin markets, especially the July meeting isn’t an appropriate time to surprise markets or implement new measures.

Balance sheet tapering to start soon

The July statement was almost identical with the June one (when rates were increased). The only change worth mentioning concerned the start of the tapering of its balance sheet. In June, the FOMC said it would do so in 2017 provided the economy evolved broadly as expected. Now, it stated: “ The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated. We think that the official announcement will be made at the September meeting and the implementation to start on October 1.

No particular concern about inflation

Following four months of slowing inflations, markets looked closely to eventual changes in the statement about the inflation outlook. Some time ago, Yellen said it was largely due to temporary factors. That assessment is very much open to debate and a few governors already expressed concerns about it and said they preferred to take a pause in the tightening cycle to see how inflation would evolve.

The changes in the statement on inflation were marginal though. In its description of recent developments (first paragraph), the statement mentioned that headline and core inflation had declined and are running below 2%. In June, the statement mentioned that they were running somewhat below 2%. On the outlook, there was no change: “Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.” and “ The Committee is monitoring inflation developments closely”.

FOMC expects further gradual tightening

“The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate” but is watching inflation developments carefully. “The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.” “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.”

Summarizing, we expect the Fed to start implementing its balance sheet tapering after the September meeting. That gives them the opportunity to keep rates unchanged in September and defer an eventual rate hike to the December meeting, if economic conditions remain good and especially if inflation doubts subside. A potential hurdle to start tapering might be the stand-off in Congress over raising the debt ceiling that may reach its zenith end September-half October.

Market reactions not so subdued

Despite the lack of much new info, the Treasury and FX markets reacted substantially in a dovish fashion. US Treasuries went up and erased Tuesday’s sell-off losses, while the dollar was sold. The T Note future rose from about 125-21 to 126-02. The curve sifted lower by 3 (30-yr) to 7 bps (5-yr). The outperformance of the 5-yr suggests that the market considered the statement as relevant for the outlook of monetary policy. EUR/USD rose from 1.1640 to 1.1735, setting a new cycle high and threatening key resistance at 1.1736 (38% retracement). USD/JPY fell to 111.20 from 1.1190. Equities couldn’t choose a distinct direction.