Weekly Analysis
Typography

The FOMC announced that QExit will begin in October, and confirmed the prospect of a hike in December......

 

The message is that the Fed is confident in the solidity of the recovery, which justifies ongoing monetary policy normalisation, despite low inflation and volatility tied to the hurricanes.  Balance sheet policy will be the underlying force and active monetary policy will be managed through interest rates, forecast on a moderate upward path, with a point of arrival at 2.75% in 2020 (from a previous estimate of the neutral rate of 3%). 

As expected, the FOMC meeting left rates unchanged and announced that the gradual reduction of reinvestments will begin in October, in accordance with the programme outlined in June. The vote was unanimous. The largest source of uncertainty ahead of this meeting was concentrated on the interest rate forecast, and especially for December. The dot plot, which illustrates individual expectations, shows widespread consensus for a rate hike by the end of the year: 4 votes for stable rates, 11 for a hike, and one vote for two hikes. Recently, many Fed presidents had raised doubts on the appropriateness of hiking rates without a clear recovery in inflation, after a semester of significant weakness. The Board, except for Brainard, remained silent (Yellen and Fischer in particular): in the internal debate, the Committee evidently has come to the conclusion that the risks of inflation proving persistently low have decreased significantly. The minutes of the meeting will shed more light on this aspect. The FOMC’s message, both implicit and explicit, is that it has confidence in the solidity of the economic recovery. In Yellen’s words: “the basic message here is US economic performance has been good (…) the steps we have taken to normalize monetary policy (…) are well justified given the very substantial progress we’ve seen in the economy”. As far as uncertainty over inflation is concerned, the Committee still holds the view that this year’s weakness is predominantly transitory, although Yellen herself acknowledged that it is not easy to point to a “sufficient set of factors that explain why inflation has been so low”.

The macroeconomic assessment in the statement remains positive for both activity and inflation, with only a few marginal changes compared to July. The statement notes that data in the near term will be influenced by the effects of the hurricanes, both in terms of activity and prices, although it stresses that “storms are unlikely to materially change the course of the national economy over the medium term”. For what concerns projections, the growth forecast for the end of 2017 has been raised (to 2.4% from 2.2%), whereas forecasts for 2018-19 are above potential, and at potential in 2020 (1,8%). The unemployment rate is forecast at 4.3% at the end of 2017 and at 4.1% in 2018 and 2019, and will stay below the equilibrium rate in 2020 as well. Core inflation has been revised down for 2017 (to 1.5% from 1.7%), but raised ma sale al 2% in 2019. The neutral interest rate has been reduced by 25bps to 2.75% from a previous projection of 3%. The forecast path of interest rates is marginally lower and flatter: in addition to the hike at the end of 2017, three hikes are envisaged in 2018, followed by two in 2019 and one in 2020. 

The only real change in the statement concerns balance sheet policy, with a single sentence announcing that the reinvestment reduction programme will begin in October, based on the rules already laid out. As Yellen said, the balance sheet will not be an active instrument for monetary policy, which will be managed using rates. According to Yellen, there is now a “high bar” to resume purchasing assets: the necessary condition would be a significant shock resulting in “a material deterioration in the economic outlook”.

The minutes, to be published in three weeks’ time, will shed further light on the debate on interest rates, although the distribution of views as illustrated by the dot plot makes a rate hike in December very likely, followed by a gradual upward path, barring significant surprise from data. Therefore, it is reasonable to expect a rate increase in December. Market reactions have mostly been concentrated on the exchange rate, in the form of a widespread appreciation of the dollar. Yields have moved modestly, whereas the probability of a hike in December has increased from a level of close to 50% up to 63.8% (Bloomberg).


Appendix
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