Following the Fed’s announcement, please see below for market views from the Global Fixed Income, Currency & Commodities Team (GFICC):
The Federal Open Market Committee (FOMC) maintained the target range of 1.50% ‐ 1.75% for the Federal Funds rate. At the press conference, Chair Powell communicated for a third meeting in a row that the current stance of monetary policy was appropriate in order to sustain the current economic expansion. On a more technical note, the Committee did vote to increase the interest on excess reserve rate (IOER) by 5 basis points to 1.60% in order to guide the effective fed funds rate towards the middle of the target range since the money market volatility experienced in September 2019 has subsided.
The January FOMC statement maintained most of the language used in December. There were no major changes to the economic assessment with the exception of a downgrade in the characterization of consumption. While the Committee still expects a strong labor market and 2% inflation as the most likely outcomes, they continue to view that uncertainties around the outlook still remain. The statement maintained that they will continue to closely monitor the data, including global developments and muted inflation pressures. The Chair’s press conference proved to be a bit more exciting than the minimally dovish changes to the statement.
There were no dissenters at the meeting.
We can break the statement into two parts:
- Economic Assessment – Very few changes; Small downgrade in the characterization of current personal consumption from “strong” to “moderate”
- Outlook – Also no major changes; Small tweak to the language regarding inflation stating that the current stance of policy was appropriate to cause inflation to “return to” the symmetric inflation target rather than remain “near” the target. In the press conference, Chair Powell acknowledged that this shift was intentional to signal that they are not satisfied with the current below 2% inflation reading and do not want to send an implicit signal that the current inflation target is a ceiling.
Chair’s Press Conference
The Chair re-iterated his message from December stating that the incoming data would need to result in a “material reassessment” in the outlook in order to serve as a sufficient catalyst for the next move in the policy rate. The Chair acknowledged recent developments with the Coronavirus in China and the potential global growth uncertainties that this may create. This risk factor is viewed as part of the overall monitoring that the FOMC has committed to conducting in order to determine if the keeping policy unchanged remains appropriate. The Chair spoke less about inflation at this meeting but continued to hint at a bias that the hurdle rate to hike was significantly higher than to cut rates.
More broadly, Chair Powell is viewing low and stable inflation as a positive factor that is allowing the Fed the opportunity to operate in an economy with a tight labor market for longer and help pull in marginalized workers into the labor force. On the other hand, he reiterated the risk that sustained inflation below target could damage inflation expectations.
The Chair spent a good deal of time discussing the existing temporary repo facilities programs and the NY Fed’s scheduled Bill purchases as being effective in stabilizing money markets. He indicated that the two programs would continue into Q2, where the FOMC estimates the appropriate level of Bank reserves will soon be reached. The Chair laid out a soft schedule for how these two initiatives would taper and eventually end. The comments got technical at times and the Chair disclosed the Fed’s estimates of the level of reserves viewed to be appropriate ($1.5B in excess reserves was described as a floor), but caveated that the program would remain flexible to address unusual funding volatility. The Chair also distanced the policy actions taken to address Repo funding from the perceived QE similarities that the market has focused on. When asked directly, he declined to connect the recent rise in risk assets to the Fed’s actions regarding repo and Bill purchases.
- We expect the Fed to keep policy rates on hold as they take a pause to assess the landscape in 2020. While the Fed remains on hold, we believe the desire to ease policy is greater than to tighten policy. Given muted inflation pressure and moderating US economic momentum, in addition to election uncertainty, we see very few meaningful upside catalysts for nominal growth.
- In today’s meeting, the Committee signaled they were still happy with where rates were and had no intention of adjusting them in the near term. Over the medium term, they appear to be uncomfortable committing to a more aggressive easing of policy until there are clearer signs of weakening in the service sector and labor markets. However, the case for the Fed to continue to ease policy in 2020 should be bolstered by low inflation and inflation expectations which remains below the Fed’s 2% target.
- Discussions on balance sheet and reserve growth will continue as the market tries to determine whether the policy initiatives taken over the last 3 months are similar enough to QE to provide a support for risk assets. The Fed will try to distance themselves from this interpretation. It appears as though the Fed’s balance sheet & reserve growth will be slowing and eventually end over the coming months barring some unusual funding risks. To the extent that investors assumed the Fed would be increasing reserves and its balance sheet indefinitely at the pace experienced in Q4, comments from the Chair today could weigh on risk sentiment.
- The Fed is continuing to conduct a monetary policy review in which they appear to be considering a modification to their inflation strategy in order to better achieve their inflation objective and avoid an unwanted downward drift in inflation expectations. Although a formal change is not imminent in the next few months, the trend of Fed speakers indicates the Committee is leaning towards some type of change that would encourage more inflation and could result in an average inflation target - which would incorporate past misses in inflation more explicitly. The result would mean more accommodative policy for longer.