Fed sticks to its plan - Rabobank

As widely expected, the FOMC kept the target range for the federal funds rate unchanged at 1.001.25% and the formal statement indicated that the Committee expects to begin implementing its balance sheet normalization program ‘relatively soon’, provided that the economy evolves broadly as anticipated, notes Philip Marey, Senior US Strategist at Rabobank.

Key Quotes

“‘Relatively soon’ had not been in the previous statement in June, but was mentioned by Yellen at the June press conference and was included in the minutes of the June meeting. The June statement still referred to ‘this year’ instead of ‘relatively soon’. At the same time, the FOMC statement did again acknowledge that headline and core inflation have declined and are running (and this time no longer ‘somewhat’) below 2%. Therefore the Committee repeated that it is monitoring inflation developments closely.”

“What’s next?

• The FOMC has three meetings left this year, in September, November, and December. Since the November meeting does not have a press conference the Committee is likely to have September and December in mind for its next moves. They indicated earlier this year that they would prefer not to confuse the public by raising the target range for the federal funds rate and announcing balance sheet normalization at the same meeting. Moreover, the FOMC expects to start normalizing the balance sheet ‘relatively soon’. This suggests that the Committee is aiming for a September announcement on balance sheet normalization and a December hike. 
• However, the Fed has also said that both actions are contingent on the current economic and inflation outlook. Our doubts about the feasibility of the Fed’s plan are primarily related to the recent decline in both headline and core inflation. For now, the majority in the FOMC is still downplaying this movement of inflation away from the 2% target, but if inflation data continue to disappoint the Committee, the doves are likely to gain ground in the coming months. If the Fed loses its composure by September, this could shift the balance sheet announcement to December and the next rate hike into next year.
• Alternatively, in an attempt to save face, they could decide to make an announcement in September, but with a considerable implementation lag, say until January. If the Fed does not lose its composure until December, a September balance sheet announcement may be the Fed’s final act this year. Either way, we do not think that the third rate hike will materialize this year.”