The Fed has bottled it! I have been saying for months that the media frenzy around a hike in September would come to nought. Never underestimate how dovish the Fed will be! The FOMC decision to hold off from a rate hike was not a major surprise, but the dovish outlook in the statement and also the press conference has been the remarkable takeaway from yesterday. This dovish announcement from the Fed will now even question the possibility of a December rate hike.
The Federal Open Market Committee (FOMC) has a dovish lean within its voting members and this has been something that I feel has been overlooked by many in the market. Whilst it is easy for one person to come up with a hawkish view and say, “the Fed will raise rates because…”, they are a voting committee of 10 and aside from the one chief hawk (Jeffrey Lacker) they have not shown enough voters turning hawkish to suggest a rate hike. The committee is clearly packed with doves.
And now we even see the voters looking even more dovish. Of the 17 “participants” in the meeting, 4 believe that a rate hike will not be appropriate in 2015 at all. This is more dovish than the 15 participants who believed a 2015 hike would be appropriate back in June. Now we do not know who those four are because there are 7 regional Fed presidents who “participate” in the meeting but do not have a vote on the policy.
Furthermore, look at the inflation expectations between the two meetings. The Personal Consumption Expenditure forecast has been cut for years up to 2017 and the Fed’s 2.0% target for inflation is now not expected to be hit until 2018. It is also interesting to see the Fed’s unemployment projection dropping below 5% which would suggest that they are now revising their assessment of what they see as “full employment” which was previously between 5.0% and 5.2%. This suggests more slack in the economy that they had previously thought.
Then there are the dot plots. The first one is for June, with the one below that for the September meeting. It is clear that for 2015 the expectations have been cut back, but also one voting member (unconfirmed rumours that this was the arch-dove Narayana Kocherlakota) thinks it may be appropriate for negative rates. Also, for 2016 there has been a slight dovish change for the outlook for 2015 and 2016.
The biggest issue is that the Fed made a significant reference to the “international developments”. I found it odd that the Fed focused far less on the strength of the labor market and although it did talking about inflation a little, the main reason seemed to be concerns over the global markets turmoil. This seemed to be referencing the CHina slowdown. However, an economy like China is like a supertanker, it is going to take a while before the economic indicators start to pick up in any meaningful way. Going forward, how does the FOMC see this one developing. If this was a reason to not hike rates in September, then surely October is ruled out (this was unlikely anyway in the absence of FOMC projections) and raises serious questions for December too. The FOMC has shown that it remains incredibly dovish, so what can turn around in the space of three months that could justify enough of the voting members to change stance?
The fed funds futures have fallen sharply in the wake of the meeting and having been pricing a probability of around 63% chance of a rate hike by December yesterday afternoon, the chances are now less than 50%. This could have huge implications for the dollar which has fallen significantly since last night.
The markets have taken a negative view of the FOMC decision. The least that was expected was an announcement that did not include a hike was that there would be a hawkish hint that a rate rise was on the way. Concerns over “international developments” suggests the Fed is extremely mindful of future growth. The shorter dated Treasuries were bound to react to the Fed standing pat with a sharp fall, but it is the huge decline on the 10 year yield that could be the most concerning as the longer dated end of the yield curve reflects the expectations on future growth. If the 10 year yield drops the below 2.11% September low, that would be a real signal sent out by the bond markets. Note also that equity markets are under big selling pressure also today amid the concerns over global growth.
Let me leave with one thought… In 2016 there is a Presidential election and the Fed will not want to be deemed too political by making such a profound shift in monetary policy too close to the November poll. I stick by my assertion that if they do not make a move in December, it may struggle at all next year.