Bank of the West Instant Analysis on September 2016 FOMC Meeting

No rate hike from the FOMC as expected today.  However, The FOMC is preparing the markets for another rate hike before the end of the year.   The FOMC statement released today added the language, “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”  This was backed up by three dissents from committee members; Ester George, Loretta Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 0.5 and 0.75%.  In past meetings only Ester George has dissented, so now she has some company in her view, if not yet a majority of the committee on her side.  The committee also rephrased and upgraded their assessment of near-term risks to the economic outlook as roughly balanced.

We continue to believe the December FOMC meeting is most likely time for the next quarter point rate hike from the Federal Reserve.

Beyond preparing the markets for another near-term rate hike, the economic and interest rate projections released along with the statement was a source of stealth dovishness for 2017  and 2018.  The median dot-plot on where the committee believe the Fed funds rate target is headed over the next three years, shifted down somewhat more than we expected, though this brings the FOMC median fed funds forecasts in-line with my current view.  The median FOMC forecast is now for one quarter point rate hike by year-end 2016, two more quarter point moves in 2017, and 3 quarter point moves in 2018.  The  long-run or terminal fed funds forecast also slipped by a tenth of a point to 2.9% from 3.0% forecast back in June.  By my count of the dots,  there are now 8 FOMC participants that think the long-run Fed funds rate target should be below 3.0 percent, that is up from just 3 FOMC participants that thought so in June.

The FOMC economic projections were a snooze.  No material change in the real GDP, unemployment rate, or inflation outlook through 2019.   Moderate U.S. economic growth continues over the forecast horizon. Estimates of Real GDP and headline PCE inflation were scaled back a bit for 2016, given the sluggish first half of the year.

Market reaction so far has been muted.  The S&P 500 is trading up 0.24% from yesterday’s close, the 5 to 30 Year maturities of U.S. Treasury bond are seeing yields fall a couple of basis points from yesterday, while  the 2 and 3 year maturities are up a fraction of a basis point.  The U.S. Dollar is trading lower against major currencies.

In short, this a very patient FOMC despite the additional dissents. Gradual Fed rate hikes over the next few years could be described as glacial rather than gradual given the current dot plot median forecasts.  Still, the Fed remains on a rate hike path, and Treasury interest rates are expected to follow the Fed gradually higher over the coming years.