The Federal Reserve did not surprise. It did not change interest rates while announcing that its plan to begin reducing its balance sheet will begin next month. Through the economic projections, the FOMC continued to signal that a hike in December is still appropriate. In fact, the dot plots show that 11 of 16 Fed members think one more hike this year will be appropriate. Four say steady and one says that two hikes this year are appropriate. Just remember, these are not forecasts. One Fed official did not forecast a 50-bp rate hike in December. It is an expression of the belief that the Fed is behind the curve, which is exactly what the easy financial conditions show.
The dot plots suggest that it will take the Fed a year longer to drive Fed funds to their neutral rate, which it lowered to 2.75% from 3.0%. However, the Fed not only left one more hike this year on the table, but it also kept the median anticipation that three hikes may be appropriate next year. To signal its slightly more gradual approach, the central bank shifted one of three rate hikes it had thought appropriate in 2019 into 2020.
The Fed's assessment of the economy did not change much. It did seem to be more candid about the inflation undershoot. But consistent with its assessment of appropriate policy, while the near-term inflation forecasts were trimmed, the longer-term was not. The Fed also accepted that the recent hurricanes will cause near-term disturbances but the underlying trajectory of the economy is not likely to be altered.
By still anticipating another hike this year, the underlying signal from the Fed was somewhat more hawkish than the market expected. The market increased the odds of a December rate hike to over 60%. The yield curve shifted higher (~5-6 bp) without much change in the slope. The dollar rallied against both major- and emerging-market currencies. Short- and medium-term market participants are short dollars in a significant way, according to the Commitment of Traders, industry surveys and indicators from the options market. Equities pushed lower, with US consumer staples and information technology selling off the hardest, while the financials and energy fared best.
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