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  • Fed Brief

    Oct 13 2015 - FOMC View Leaves Market Stuck on Roller Coaster of Uncertainty

    The Federal Open Market Committee (FOMC) decided to leave the target range for the federal funds rate unchanged at 0 to percent. That vote, however, was not unanimous. Richmond Fed President Lacker dissented, as he preferred to raise the rate by 25 basis points at the September meeting.

    From our perspective, the FOMC made the right data-based decision at the September meeting.

    In reviewing the directive, it appears that the decision to leave the target range unchanged revolved around the following factors:

    • Downward pressure on inflation
    • Market-based measures of inflation compensation having moved lower; and
    • A view that recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term

    The policy directive didn't say so explicitly, yet it is evident that the goings-on in China, which include an economic slowdown, a stock market crash, and a devaluation of the yuan, were influential in driving the decision at the September meeting.

    The latter point becomes clear in the understanding that the July 29 directive made no mention of global economic and financial developments as a negative factor.

    The FOMC has noted in recent directives that it would be assessing financial and international developments, among other things, in determining how long to keep the target range for the federal funds rate between 0 and percent. The assessment at the September meeting, apparently, wasn't too bright.

    On a related note, the 2016 and 2017 real GDP and PCE inflation central tendency projections were marked lower at the September meeting; meanwhile, the so-called "dot plot" showing participants' assessment of when would be the appropriate time to raise rates showed a reduction in the number of participants expecting a rate hike this year (from 15 to 13) and a bump in the number of participants expecting the appropriate time to be in 2016 (from 2 to 3) and 2017 (from 0 to 1).

    These shifts are the basis for suggesting the September directive is dovish. To be sure, they will plant seeds of market-based hope that a rate hike will be forestalled until 2016.

    That view of course will be subject to change based on incoming data, but for a data-dependent Federal Reserve aiming to be "reasonably confident" it can lift the target range for the federal funds rate without causing undue harm to the U.S. economy, we suspect it will want to have a multi-month slate of data to examine versus a single month.

    It's worth reminding readers that the majority of participants still expect a rate hike before the end of the year; however, the market appears to doubt the plausibility of that scenario.

    That can be said based on the understanding that the dollar weakened after the FOMC decision, Treasuries rallied sharply after the FOMC decision, and the S&P 500 financial sector, which has been anxious to see rates go up to bolster net interest margins, sold off after the FOMC decision.

    We'd caution not to get too caught up in the knee-jerk reactions. We point them out only to highlight what the first impression of the latest FOMC decision and outlook has been.

    In her press conference, Fed Chair Yellen made every attempt possible to remind listeners that a rate hike could still happen before the end of the year. We suspect that was by premeditated design so capital markets didn't take for granted that a rate hike was out of the question in 2015.

    It might not be part of the official job description, but part of the Fed chair's job is to manage the market's expectations. In that vein, Ms. Yellen had her manager hat on when taking questions and attempting to reconcile how a rate hike could actually occur before the end of the year when participants have lowered their projections for PCE inflation for 2015, 2016, and 2017.

    She didn't do the most convincing job in our estimation. What Ms. Yellen ultimately did was leave the market alone to play its guessing game about when the first rate hike since June 2006 would occur.

    Right now, the best guess pinpoints 2016, yet the "dot plot" showing a majority of members still leaning to 2015 for the first rate hike is a subplot market participants would prefer not to be dealing with.

    The threat of a near-term rate hike remains out there, and because it does, the element of uncertainty around monetary policy does too.

    What that should ensure is that the roller-coaster ride the capital markets have been on since August will keep going, twisting and turning, and perhaps being thrown for a loop occasionally, with incoming data and inter-meeting speeches from Federal Reserve officials.

    --Patrick J. O'Hare, Briefing.com

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