FOMC is still aiming for a third hike before the end of the year - Rabobank

"As widely expected, the FOMC announced the start of its balance sheet normalization program," note Rabobank analysts.

Key quotes:

"Starting in October only principal payments that exceed gradually rising caps will be reinvested. The cap will start at $10bn per month and increase in steps of $10bn at 3-month intervals until it reaches $50bn per month. Note that the initial $10bn cap and following $10bn steps are composed of $6bn for US treasuries and $4bn for agency MBS and agency debt. Once the caps reach their respective maximums of $30bn/month for treasuries and $20bn/month for agency debt and MBS – which is 12 months after the start of the normalization program –, they will remain in place until the FOMC judges that the Fed is holding no more securities than necessary to implement monetary policy efficiently and effectively."

"Still aiming for a third hike"

"Also, as widely expected, the FOMC did not change the target range for the federal funds rate, which therefore still stands at 1.00-1.25%. Most of the market’s interest was focused on the dot plot, which showed that the FOMC is still aiming for a third hike before the end of the year, and three more in 2018. The three hikes that were projected for 2019 in the June projections, are now spread across 2019 (the first two) and 2020 (the third). This would bring the fed funds rate slightly higher than the longer run forecast, which was reduced to 2.8% from 3.0%. The FOMC noted that past experience suggests that the storms are unlikely to materially alter the course of the economy over the medium term, and they could boost inflation temporarily because of higher prices of gasoline and some other items. The Fed’s decision and projections were interpreted as hawkish and boosted US treasury yields and the US dollar."

"While the Fed remains on course, we still have our doubts about the third rate hike. Note that the minutes of the previous meeting, in July, revealed a fierce debate about the inflation outlook. At the press conference, Fed Chair Yellen was not able to offer a good explanation for low inflation this year. We expect core inflation to continue to fall short, which should induce the FOMC to delay the next hike to next year. Note that retiring Vice Chairman Fischer – who would be inclined to vote for a hike – will no longer be a voter at the next two meetings. What’s more, the balance sheet normalization that starts in October already implies an automatic pace of monetary tightening that is equivalent to one rate hike of 25 bps per year, according to our calculations."

"Looking further ahead, we would like to note that the projections made by the current FOMC for 2018 and beyond may be less relevant than usual. Vice Chairman Fischer will retire next month, while Chair Yellen’s term ends by the end of January next year. This means that 4 of 7 seats in the Board of Governors – including the two most important members of the FOMC – will be appointed by the Trump administration, which could have an impact on the course that the Fed will take in the coming years."