As widely expected, the Federal Open Market Committee (FOMC) left the target range for the federal funds rate unchanged between 1 and 1-1/4 percent.

The Committee announced its plan to gradually reduce its balance sheet by tapering reinvestments in its Treasury and MBS portfolio. As previously telegraphed in its addendum to the June statement, the Fed will runoff at $10 billion per month initially ($6bn for UST/$4bn for MBS), raising it gradually to $50bn per month by October 2018, with the same 60/40 split between UST and MBS. 

The statement made few changes to its assessment of the economy, noting the continued strength in job growth, and pick up in investment activity. The Committee recognized the negative impact of recent hurricanes on near-term economic activity with a boost expected thereafter as rebuilding begins. Moreover, it indicated that it anticipates a temporary effect on inflation as gasoline and other items rise in price due to shortages – particularly due to refinery outages in southeast Texas. 

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The Summary of Economic Projections (SEP) showed a slightly lower median unemployment rate in 2018 through 2019, with the rate hitting an expected trough of 4.1% (from 4.2% previously), before rising to 4.2% in 2020. The expected rate over the longer-term remained unchanged at 4.6%. The SEP also brought down the median estimate for core PCE inflation to 1.5% (from 1.7%) by the end of 2017 and to 1.9% (from 2.0%) by the end of 2018. Long-term rates were unchanged.

Importantly, the SEP interest rate projections for the near-term were largely unchanged, even as longer-term expectations edged lower. The median dot still suggests one more hike later this year and three additional hikes in 2018. However, the median estimate fell to 2.7% (from 2.9%) in 2019, and the longer-term median interest rate projection edged down a similar amount to 2.8% (from 3.0%) with the central tendency falling to 2.5% to 3.0% (from 2.8% to 3.0% previously).

Key Implications

As was widely expected, the Fed has finally embarked on a course of balance sheet normalization beginning next month. The balance sheet runoff will be very gradual, and markets have so far taken the reversal of the printing presses in stride. However, given the complicated nature of the financial linkages across the monetary system, we believe there is still some scope for increased volatility as global financial markets begin to feel the turning QE tide of the world’s largest central bank.

With the details on balance sheet normalization sticking to the script laid out in June, we were focused on changes to participants projections. But, here too there was little to get excited about. Participants marked to market their expectations for inflation, but balanced this with a slightly lower unemployment rate through the next two years. That said, the movement down in long-term expectations for the federal funds rate appears fairly broad-based, with five dots at 2.5% or less (from just one at 2.5% in June), vindicating the recent financial market moves in longer-term yields.

The Committee indicated that while recent hurricanes are likely to impact inflation and economic activity in the near term, disrupting it first and then boosting it thereafter as rebuilding begins, the storms are “unlikely to materially alter the course of the national economy over the medium term.” As such, we expect the Fed to see through any of the volatility in the data over the coming months in so far as it pertains to their outlook for the national economy, with the storms unlikely to prevent the Fed from potentially raising rates at their December meeting – particularly should inflation data firm by then as we expect.

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