FOMC holds rates steady, here are the implications

As widely expected, the FOMC has kept interest rates on hold at a Fed Funds target range of 1.50% to 1.75%. In the absence of a press conference or economic Projection Materials this month, the FOMC statement was the only thing to take a steer from. The FOMC has just moved to moderate tightening expectations and the market has reacted to this mild dovish tilt.

 

In March, the last time the FOMC hiked interest rates, aside from the unanimous decision (of the only eight voting members), in the FOMC statement there were four factors to really take interest in:

• Inflation – has increased but remains low; also that the FOMC is “monitoring inflation developments closely”
• Economic activity – expected to expand at a “moderate pace”
• Near term risks – “appear roughly balanced”

How have these factors developed? In the May statement there was an acknowledgement that inflation is now running close to the 2% target.

• Inflation – this is the main factor in the statement, with the Fed including the comment that inflation on a 12 month basis “is expected to run near the Committee’s symmetric 2% objective over the medium term.” This suggests that the FOMC expects inflation to start hovering around the target. If so this implies that there is little need to get more aggressive with  its tightening.
• Economic activity – continues to expand at a “moderate pace”
• Near term risks – still “appear roughly balanced”

Here are the changes, as from ZeroHedge:

 

The outlook for rates this year

At the March FOMC meeting, the dot plots suggested that the FOMC was moving towards four 25bps rate rises this year, but were not quite there yet.  The prospects for rate hikes this year are likely to be moderated after this announcement. The trend has been to move towards pricing for four hikes, but now this could be put on the shelf for the time being. According to Fed Funds futures earlier today, market pricing suggested that three hikes were nailed on but a fourth was in the balance.. In front of today’s FOMC, a June hike was a given at 94% probability, whilst September was borderline but not guaranteed at 68%, whilst three hikes the end of the year (at the December meeting) was highly priced in at 91% but having had a fourth was just 50%.  In the initial moves, the June hike is still nailed on, whilst September is now a more likely 75%, but it is the December futures that the dip in probability has been seen, with a move lower to 45%. It still seems that three are more likely than four hikes this year.

 

Market reaction

Trades have taken this as a mildly dovish statement, in that the current outlook remains fairly steady. The fact that inflation is not expected to start pushing above the target of 2.0% will suggest that there is little need to be more aggressive in tightening.

Treasury yields have dropped with the US 10 year yield lower by around 1.5 basis points after the statement, from 2.9775% to around 2.96%

The dollar has been strong moving into the FOMC, however, has slipped back in response, however there is considerable support with recent key levels breached now becoming supportive. On the Dollar Index that means the immediate support band 92.00/92.50.

• EUR/USD has added around 50 pips. The resistance of notes comes in the band $1.2090/$1.2155
• GBP/USD has pulled c. 40 pips higher. Initial resistance is at $1.3710
• USD/JPY has dropped 20 pips. Support comes in around 109.00
• Gold has moved $7 higher. This means it is back above the key support band $1300/$1310 once more.