The Fed Did Not Surprise

Federal Reserve Building

The Fed basically delivered what the markets were expecting.

The Federal Reserve did not surprise.  It did not change interest rates while announcing that its plan to begin reducing its balance sheet will begin next month. Through the economic projections, the FOMC continued to signal that a hike in December is still appropriate.  In fact, the dot plots show 11 of 16 of the Fed members think one more hike this year will be appropriate.  Four say steady and one says that two hikes this year are appropriate.

Remember these are not forecasts.  One Fed official did not forecast a 50 bp rate hike in December.  It is an expression of the belief that the Fed is behind the curve and that is what the easy financial conditions show.

The dot plots suggest that it will take a year longer to reach the Fed funds to reach their neutral rate.  However, the Fed did not only leave one more hike this year on the table, but it also kept the median anticipation that three hikes may be appropriate next year.  To signal its slightly more gradual approach was to shift one of three rate hikes it had thought appropriate in 2019 into 2020.  Furthermore, the Fed cut the long-term rate from 3.0% to 2.75%.

The Fed’s assessment of the economy did not change much.  It did seem to be more candid about the inflation undershoot.  But consistent with its assessment of appropriate policy, while the near-term inflation forecasts were trimmed, the longer-term was not.  The Fed also accepted that the recent hurricanes will cause near-term disturbances but the underlying trajectory of the economy was not likely to be altered.

By still anticipating another hike this year, the underlying signal from the Fed was somewhat more hawkish that the market expected.  The market increased the odds of a December rate hike to over 60%.  The yield curve shifted higher (~5-6 bp) without much change in the slope.  The dollar rallied against the major and emerging market currencies.  Equities slipped lower, with US consumer staples and information technology selling off the hardest, while the financials and energy fared best.

Short- and medium-term market participants are short dollars in a significant way.  This is apparent in the Commitment of Traders data, industry surveys, and indicators from the options market.  As such, today’s moves may be more about positioning than anything else.