Instant Analysis: FOMC announces balance sheet unwind will begin in October
The FOMC maintained a brave face on the monetary policy normalization front this month despite near-term economic disruption from fall hurricanes and downwardly revised core-inflation forecasts that suggest the Fed will continue to miss on its 2.0% inflation target into 2019. The FOMC statement did acknowledge the negative impact of the hurricanes on economic activity in the near term, but maintained the view that the economic disruption would prove temporary and not materially alter the course of the national economy over the medium term.
As was widely telegraphed before the meeting, the committee decided to go ahead with the balance sheet normalization program in October at the expected $10 billion a month pace. In addition, the Fed dot-plot median is solidifying on three rate hikes this year, which means another rate hike in December can be expected.
Even so, the dot plot also signaled an important evolution in thinking on where short-term U.S. interest rates are headed longer-term. The Fed funds terminal rate is now expected to settle at 2.8% − a full 20 basis points lower than the level the Fed projected last June. Moreover, fewer FOMC members see aggressive rate hikes in 2018 and 2019, as we anticipated. The FOMC median estimate for the Fed funds rate in 2019 also dropped 20 basis points to 2.7%.
While the FOMC median estimate for the Fed funds rate in 2018 still has three-quarter point rate hikes, more members did migrate their estimates lower for next year as well. Only four members now see the 2018 Fed funds rate ending higher than the median estimate, compared to seven members at the June meeting. Also, five members now see the Fed funds rate at the end of 2018 as lower than the median, an increase from four members at the June meeting. Two FOMC members, probably Kashkari and Bullard, now see no additional rate hikes in December or in 2018.
Median core-PCE inflation forecasts were revised 0.2 percentage points lower for this year and 0.1 lower for 2018 to 1.5% and 1.9% respectively. No material changes were made to the median real GDP or unemployment rate forecasts since the June FOMC meeting, though real GDP for this year was revised up by two-tenths to 2.4%.
Treasury yields are rising across maturities led by the belly of the curve. The 5-Year Treasury yield is up 4.9 basis points from yesterday to 1.883%. The 10-Yr Treasury is up 3.2 basis points to 2.276%. U.S. stocks are mixed with the S&P 500 and NASDAQ trading 0.14% and 0.35% lower, respectively. The dollar is rallying up 0.68% from yesterday’s close.