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Fed Upbeat About Employment, Next Rate Hike Data Dependent

FOMC voted unanimously to leave its policy rate within a target range of 0.50-0.75%. The outcome had been widely anticipated as the Fed just adopted rate hike of +25 bps in December. Only minor changes were seen in the accompanying statement. In short, policymakers retained the stance that future interest rate change would be ‘data dependent’. They also reiterated that economic conditions will evolve in a manner that will warrant only gradual increases in the federal fund rate’. The market has only priced in 2 rate hikes this year, although the December dot plot signaled there might be 3. CME’s 30-day Fed fund futures suggested a 17.7% chance of rate hike in March, down from 20.3% prior to FOMC meeting. Yet, they priced in a 38.8% chance in May, compared with 37.7% the day before the meeting.

As mentioned in the statement, the Fed noted that ‘measures of consumer and business sentiment have improved of late’. This is a positive tweak, appearing for the first time, which indicates policymakers’ acknowledgement of the rise in consumer and business confidence. On the flip side, however, they suggested that ‘household spending has continued to rise moderately while business fixed investment has remained soft’.

The Fed is comfortable with the improvement in the employment market. As suggested in the statement, ‘the labor market has continued to strengthen. Job gains remained solid and the unemployment rate stayed near its recent low’. On another component of the dual mandate, inflation, the Fed acknowledged that ‘inflation increased in recent quarters but is still below the Committee’s 2% longer-run objective. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance’.

To conclude, the Fed’s view on the economic outlook has not changed, with overall growth remaining ‘moderate’ and the balance of risks ‘roughly balanced’. The focus will now turn to Chair Yellen’s Congressional testimony on February 14-15. During the 1.5 week period, we would receive the employment report for January

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