Wednesday's FOMC statement was little changed from July. It reiterated that there was “significant” slack in the labor market, despite continued improvement. It repeated that rates would likely remain low for a “considerable” time after the end of QE. It also again indicated that even after the Fed’s employment and price objectives were near, Fed funds would likely remain below the “normal” long-run level. The Fed’s economic assessment saw minor tweaks recognizing the ongoing improvement of the economy.
That was largely in line with our expectations and more dovish than the market expected. However, the quick, knee-jerk market reaction heard a hawkish statement. First, there were two dissents: Plosser and Fisher. The objections were over the forward guidance. They did not advocate an immediate rate hike -- unlike the two dissents from the Bank of England.
Second, the Fed’s dot-plot saw a small increase in the Fed funds at the end of next year -- from 1.125% to 1.375%. However, as Yellen has cautioned before, the dot-plot is not policy. Nevertheless, U.S. interest rates rose across the curve and the dollar rallied across the board. The market seemed to avoid sterling, which was little changed and expressed its bearishness by selling the euro, yen and Australian dollar. Equities rallied.
We suspect the market read into both the statement and its projections a greater hawkishness than the majority of Fed intended. The big-picture view has not changed. The Federal Reserve will hike rates around the middle of next year. The Fed will likely raises rates 2-3 times in 2015. We had been thinking Fed funds would finish 2015 near 1.0%.
We're reluctant to alter that view based on Wednesday’s statement.