14 June 2018
Changes in the “dots” aside, the Fed’s approach to monetary policy is back to “business as usual”, certainly according to its statement. It acknowledged the US economy’s strength, with inflation close to target and a healthy labour market. Gone was the paragraph urging caution, where Fed Funds were seen below their longer run equilibrium. Forward guidance is now more balanced, with the focus firmly on data releases. And, as Fed Chairman Powell stressed during the roundly bullish press conference, the data warrants higher rates.
The Fed’s communication strategy is also changing. The statement was much shorter than its predecessors, and simpler too; perhaps a reflection of Powell’s more direct style compared to Yellen’s. Starting from January 2019, the Fed will hold a press conference after each monthly meeting, compared with the current quarterly schedule.
The market presently gives more weight to meetings that are followed by a press conference, as they are deemed more likely to deliver rate changes. Holding a monthly conference gives the Fed more flexibility to shift policy as they see fit. However, it could also make every meeting “live” in the market’s eyes, increasing volatility in rates.
Lastly, the IOER (Interest on Excess Reserves) was raised by 20 basis points; less than the change in the Fed Funds target. While Powell noted that the change was only a technicality, at the margin it does indicate that the Fed remains undecided about the natural level of reserves, the long-term size of its balance sheet and the target end state for monetary policy.
Markets reacted quickly to the bullish tone of both the statement and the press conference, with US Treasury yields moving higher by 3-4 basis points and the curve flattening. Looking ahead, the path of least resistance remains for higher yields, particularly at the front end of the curve - as long as US data continues to deliver.
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