Yellen’s Swan Song: Few Surprises

new nature

The Federal Reserve hiked the Fed funds target by 25 bp for the third time this year, as was widely expected.   Both the Chicago and Minneapolis Fed presidents dissented.  Next year, they will not vote, and this will give the Fed a slightly more hawkish bias among voting members in 2018.   Although it remains a bit of a mystery for Fed officials, Yellen was clear that the recent softness is thought to be transitory. 

 The Fed upgraded its assessment of the economy.  In the statement, it referred to “solid” job gains and said the labor market “remained strong.”  It cuts its unemployment forecast in 2018 and 2019 to 3.9% from 4.1%.  Growth for next year was revised higher in the median forecast to 2.5% from 2.1%.  However, the long-term growth forecast was unchanged at 1.8%.  Yellen was explicit that change in the tax policy would support modestly stronger growth, but the forecasts, show that the changes are not expected to change trend growth.  In response to a question, Yellen revealed that most officials “factored in the prospect of fiscal stimulus.”

The Fed continues to expect to hikes rates three times in 2018.  The median year-end dot plot was unchanged at 2.125%.  The median dot for 2019 was also unchanged at 2.688%.  The 2020 median dot was lifted to 3.1% from 2.9%.  Despite the increase in the 2020 median expectation, the long-run rate was unchanged at 2.8%.   The Fed funds futures appear to be discounting a little more than a 50% chance of a March 2018 hike.  The OIS appears to be pricing in closer to 65% chance.

The Fed also confirmed its balance sheet operations.  Starting in January, the balance sheet will be allowed to decline by $20 bln a month.  It was $10 bln a month here in Q4 and will rise to $30 bln a month in Q2 18 and $40 bln a month in Q3 18 before reaching its terminal velocity of $50 bln a month in Q4 18.

The dollar was trading heavily before the FOMC statement and quickly dropped to new lows against the major currencies.   US rates eased and the curve flatten (bullish flattening). Note that around that same time, news broke that the UK government lost a critical vote in the House of Commons.  A group of Tory backbenchers joined Labour to ensure Parliament a “meaningful vote” on the deal struck with the EU.