The Fed surprised today by issuing a much more hawkish statement than expected.
- First, the Fed decided to strengthen the language on the labour market by now pointing to solid job gains and also saying that "on balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing", a change from the "significant underutilization" description in previous statement
- Second, the Fed didnt soften the language on inflation as much as expected as they continue to state that "the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year". They do note, though, that market inflation expectations have declined and that near term inflation will likely be held down by "lower energy prices and other factors".
- Third, the Fed concluded asset purchases without leaving any comment that it could be restarted, should the outlook be worse than expected. Instead, the Fed reiterates that hikes could come later if progress towards their targets proves slower than expected. But they also still say that hikes could come sooner if progress is faster. So there is symmetry here still.
- Finally, neither Fisher or Plosser dissented at this meeting as at the previous meeting. This is very telling about the tone of the discussion and indicates that it is moving in their direction. Fisher has earlier this year refrained from dissenting because he felt the discussion was moving his way. Instead Kocherlakota dissented as he favoured a continuation of purchases and stronger commitment to keep rates unchanged untill the 1-2 year inflation outlook had returned to 2%.
The Fed kept the "considerable time" forward guidance but it is now very likely that it will go at the December meeting.
Bottom line: as hawkish a statement as it could have been given current circumstances. We yesterday moved our expectation of the first rate hike from April next year to June based on the decline in inflation. However, this is still earlier than what the market is pricing (around October/November) and a hike already in spring can still not be ruled out. Next week we expect another decent labour market report and given todays hawkish statement it could push short yields and rates further up in the short term. It is also giving more support to the USD.
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