Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities (GFICC) group:
Consistent with our and the market’s expectations, the Federal Open Market Committee (the FOMC) increased the Fed Funds rate by 25 basis points to 1%‐1.25%. In addition to the rate increase and the release of the FOMC Statement, Fed members also updated their Summary of Economic Projections. Included with the release was an addendum regarding balance sheet policy. Chair Yellen also hosted her quarterly press conference.
The June Statement indicated that the underlying strength of the US economy remains firmly in tact. However, the weaker realized inflation data was acknowledged and remains a watch item going forward. The FOMC continues to characterize the path of future rate hikes as gradual.
The market also digested an update to the Summary of Economic Projections and a more detailed discussion of the balance sheet. Within the projections, the growth and inflation outlook were effectively unchanged for 2018 and 2019. For 2017, the growth outlook was modestly marked upward while the inflation outlook was altered downward to reflect recent disappointments in the price data. The unemployment rate estimates were cut for the next few years, reflecting the recent improvements. The long-run unemployment rate declined modestly. The famous Dot Plot was mostly unchanged with the exception of some modest shifting as one member of the Committee left and a new regional president joined since March. The median Dots were unchanged in 2017 and 2018, while 2019 fell slightly (1/2 a hike). The median long-run Fed Funds rate remained unchanged at 3%.
We can break the Committee’s statement into parts:
Following the statement was an addendum update to the “Policy Normalization Principles and Plans” which mostly mirrored the plans presented by the staff in the May minutes for the balance sheet reinvestment process. The Committee pre-announced caps (or limits) on the amount in which the balance sheet can shrink in any given month. The caps will be initiated at $6B for Treasuries and $4B for mortgages, and will gradually rise by the initial amounts for the next 12 months until the terminal sizes of $30B and $20B, respectively are reached. Neither the terminal size of the balance sheet nor the official start date of the program were provided.
There was one dissenter at the meeting, Minnesota President Neel Kashkari who preferred to keep the Federal Funds rate unchanged.
At the press conference, Chair Yellen remained optimistic in light of recent labor market, inflation and growth developments. This optimism in the underlying strength in the US economy was used to justify additional rate hikes. She noted the substantial easing of financial conditions over the period but spent most of the time explaining the Committee’s view on the inflation outlook. She cautioned putting too much emphasis on a few weak inflation data points. The Chair echoed the information on the balance sheet within the statement and addendum, and communicated that changes would be well understood by the market by the time they are implemented. Chair Yellen reiterated that the Fed Funds rate would be the primary policy tool and balance sheet adjustments would be done in a gradual and least disruptive way as possible.