FOMC Statement & Potential Impact on Fixed Income
Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
Consistent with our and the market’s expectations, the Federal Open Market Committee (FOMC) kept the Fed Funds rate unchanged at 1 – 1.25%.
The November statement indicated that the underlying strength of the US economy remains firmly intact despite weather impacts. The language on inflation was unchanged. The Committee continues to acknowledge that their preferred measure of inflation is currently running below their target and remains a watch item going forward. The FOMC continues to characterize the path of future rate hikes as gradual. The statement also highlighted that balance sheet normalization (as described in the June FOMC addendum) is underway.
We can break the Committee’s statement into four parts:
- Economic Assessment – the Committee upgraded its assessment of the labor market and the overall US economy, despite the hurricane-related impacts. The Committee also looked past the recent acceleration in headline CPI as a by-product of gasoline supply disruptions.
- Outlook – the Committee anticipates hurricane related volatility in reported economic activity but is going to look through it. They expect further growth and strengthening of labor market conditions as well as an eventual return of inflation to its 2% objective, but they are keeping a close eye on inflation.
- Forward Guidance – was left unchanged, as the Committee continued to describe future actions as ‘gradual’ and their current policy stance was accommodative.
- Balance Sheet – was briefly mentioned in a concerted effort to minimize the impact it will have on decisions going forward.
There were no dissenters at the meeting.
Our view:
- The FOMC statement was a non-event and was intentionally written to maintain optionality around a rate hike in December. As a result, the market continues to price in more than an 80+% probability of a rate hike by year-end. The Committee was slightly more optimistic on the developments in the real economy. They appear fairly confident that the positive developments in the labor market will allow them to push ahead with another rate hike in December as long as inflation continues to improve.
- The Committee continues to favor a gradual approach to tightening policy as they juggle incoming information on inflation, growth, and fiscal policy. We continue to expect the balance sheet normalization plan will run on autopilot as a secondary tool, while rate hikes will remain the primary tool of removing accommodation.
- Despite the recent weakness in inflation readings, future rate hikes are still warranted as the unemployment rate continues to reach new cycle lows, and growth remains above-potential and appears to be accelerating in H2 2017. Any progress on new fiscal policy will play an important role in the FOMC’s decision-making process for the number of rate hikes the US economy can handle in 2018.
- The FOMC’s reaction function in 2018 will also be dependent on the views of the next Fed chair. The decision on Fed leadership is expected to be announced later this week. The composition of the FOMC is expected to change rather notably over the next few months. Randal Quarles attended his first meeting today and filled one of four empty slots within the Board of Governors.
- We expect the Fed will raise rates one more time in 2017 as cyclical forces push inflation back toward a more trend like level, financial conditions remain very easy, and labor markets continue to tighten. We see 10-year yields ending the year around 2.5% in a trading range of 2.25 – 2.75% due to continued improvement in US and global fundamentals.