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 1.25% – 1.50%.

The January statement indicated that the US economy remains solid and that strength is broadening. The language on inflation was upgraded to recognize improvements in market based measures of inflation expectations. The Committee continues to acknowledge that its preferred measure of inflation is currently running below its target. The FOMC continues to characterize the path of future rate hikes as gradual.

We can break the Committee’s statement into four parts:

• Economic Assessment – the Committee maintained its positive view on economic momentum and upgraded its assessment of inflation expectations.
• Outlook – the Committee expects further growth, strengthening of labor market conditions, and a rise in inflation this year requiring additional adjustments to the Fed Funds rate. They continue to keep a close eye on inflation.
• Forward Guidance – was effectively left unchanged, as the Committee continued to describe ‘further’ increases as ‘gradual’ and their current policy stance was accommodative.
• Balance Sheet – this policy is no longer mentioned in the statement but the balance sheet run-off continues as described in the June FOMC addendum.

There were no dissenters at the meeting.

Our view: 

• The FOMC statement was reflective of a mark-to-market on the recent data and was intended to serve as a hand-off to the new Fed leadership. Positive developments in growth and inflation have allowed them to feel comfortable continuing to communicate a gradual path for rate increases and a slow balance sheet run-off.
• The Committee continues to view future rate hikes as warranted. Fiscal policy initiatives will continue to play an important role in the FOMC’s decision-making process in 2018. If spending increases and/or tax cuts result in stronger economic data, the Committee median may begin to lean towards four rate hikes in 2018.
• The composition of the FOMC is expected to change dramatically over the next few months. This was Chair Yellen’s last meeting. The incoming Chair, Jerome Powell, will likely make his first appearance as Chair at the Humphrey Hawkins testimony in February. NY Fed President Dudley will be retiring from the FOMC in a few months. There will be four open spots on the Board of Governors, including the Vice Chair of the Board which is expected to be announced shortly. Marvin Goodfriend has been nominated for one of the remaining four positions leaving lingering uncertainty. Jerome Powell, the next Federal Reserve Chair, represents continuity in leadership. We expect he will maintain many of the same policy approaches as Chair Yellen, at least in the first few months of his chairmanship. Powell does represent more of a change on the regulatory reform side. He has publically discussed his agenda to reduce some regulatory burden and complexity over the coming year.
• The Fed also re-confirmed its Statement on Longer-Run Goals and Monetary Policy strategy. Although the document was unchanged, we do expect more public conversations in the upcoming months on this topic. Specifically, some members of the Committee have expressed interest in re-evaluating the current 2% inflation target against an inflation band or price level target.
• We expect the Fed will raise rates 3-4 times in 2018 as cyclical forces push inflation back toward trend like levels, financial conditions remain easy, labor markets continue to tighten, fiscal expansion begins and regulatory reform takes shape.
• Improving global growth will create an environment that is supportive of risk assets at the expense of Treasury yields, despite the coming contraction in global central bank liquidity. The change in the FOMC’s balance sheet has been widely publicized and well telegraphed and the knock-on impact to markets so far has been muted as the run-off remains minimal. We anticipate the size of the run-off in 2018 will be between $300 – $400 billion, dependent on MBS pre-payment.
• We expect that the reduction in global central bank liquidity in 2018 will move more into the market’s purview as the year progresses and could cause an increase in volatility.
• After remaining stubbornly weak, we see signs that inflation is rising to a pace closer to the Fed’s longer-run target, albeit at a gradual pace. This will allow 10-year yields to continue to move higher in 2018.