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Unsurprisingly given the strength of US data year-to-date and the reluctance by US policymakers to open the conversation around further hikes, the Fed maintained rates at 5.25-5.50%, in line with market consensus and our own pre-announcement call.
Perhaps the most notable change instead came in the Fed’s latest communication, where just the third sentence of the policy statement now highlights that “In recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective.” Supported by a slight tweak in the characterisation of risks, noting that they “have moved into better balance over the past year” as opposed to actively “moving into better balance”, the policy statement sounded marginally more hawkish.
Attentive to the market risks of sounding overly hawkish, however, the rate statement also maintained the forward guidance that “the Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent”.
This reinforces recent commentary by policymakers that the current configuration of monetary policy is sufficient in bringing down inflation, but that it will likely take longer than expected. This view was similarly confirmed by Chair Powell in the press conference, where he stated that “we believe policy is sufficiently restrictive if maintained over time”, before going one step further by saying that it is “unlikely” that the next policy step is a hike. This outcome largely met our expectations that the Fed would sound marginally hawkish in its characterisation of recent data, but would stop short of endorsing no cuts this year or even the discussion of further rate hikes, befitting with Powell’s intermeeting commentary on the sidelines of the IMF.
The dollar drops alongside Treasury yields as Powell sets a high bar for hikes and the Fed tapers QT moderately faster than expected
The outcome of today’s meeting has done little to dent our confidence in both our Fed call, and our view on the dollar.
Powell’s tone suggested that the bar for further rate hikes remains high, but so is the burden of proof for future cuts. With only two further jobs and inflation reports due before July’s meeting beyond this month’s releases, which should remain strong based on momentum alone, we doubt the Fed would be able to find sufficient confidence on inflation returning back to 2% by then.
As a result, today’s meeting reinforces our view that the Fed’s first rate cut is unlikely to occur before September.
Furthermore, contrary to today’s market reaction, which has seen the dollar selloff in an aggressive fashion as yields dropped on Powell’s refusal to fuel speculation over rate hikes and the Fed’s plans to taper QT quicker than expected, we think the Fed’s reluctance to cut rates should sustain the dollar’s path higher. That said, given the current reluctance by Fed members to open the door to further hikes, we doubt the dollar’s rally can sustain the pace recorded over recent months.
Fed begins to taper its QT programme
Outside the headline rate decision, the Fed also chose to slow the rate at which it reduced its asset holdings, as was widely expected. Perhaps of note, however, was that the Fed plans to taper modestly faster than anticipated, a decision that skews dovish and runs counter to the Fed’s aim of taming inflation. Granted, this point was rejected by Chair Powell in his statements, but with markets having expected a somewhat faster pace of roll off, today’s announcement has weighed on Treasury yields at the margin, in turn helping to ease financial conditions. Interestingly, while not capturing much attention in Chair Powells press conference, there was a tacit admission that the decision to run down the balance sheet more slowly may have been driven in part by concerns around market functionality. For now though, we are reluctant to read too much into what could have been an offhand statement in a single press conference. All told, having broadly telegraphed a slowdown in the balance sheet runoff back in March, we suspect that the net-result of this latest announcement is of little immediate consequence, though longer term it could well be something for traders to keep a closer eye on.
Authors:
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst