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The July FOMC meeting came in as widely anticipated. The Fed left its monetary policy unchanged, maintaining the federal funds rate target at 1-1.25%. The Fed made two tweak in the statement, though. First, it noted that balance sheet reduction would begin 'relatively soon', signaling that the official announcement would come in September. Second, policymakers revised lower the outlook on core inflation. US dollar plunged, with the weighted index falling to a 13-month low as the market interpreted the inflation assessment as dovish.

As indicated in the concluding paragraph of the accompanying statement, the Fed is maintaining, 'for the time being', the reinvestment of principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. It expects to begin implementing its balance sheet normalization program 'relatively soon', given that 'the economy evolves broadly as anticipated'.

Policymakers acknowledged that the overall inflation and the measure excluding food and energy prices (core inflation) have 'declined' and are 'running below 2%'. The removal of the word 'somewhat' signaled the weakness in inflation is more than the Fed had anticipated. They noted that 'market-based measures of inflation compensation remain low' while 'survey-based measures of longer-term inflation expectations are little changed, on balance'. Yet, the Fed retained that the long-term inflation would have 'a sustained return to 2%'.

For now, we believe the Fed would make an official announcement of the balance sheet reduction process in as soon as September. We continue to expect the Fed would deliver one more rate hike this year, likely in December, unless the economic growth and inflation prints decline dramatically.

As expected, the Fed maintained the target rate at 1.00%-1.25%. As this was a small meeting without updated projections and a press conference, focus was solely on the statement. However, the statement was without any big changes as per usual.

One change in the statement was that it now says that the process of unwinding the balance sheet may start 'relatively soon' instead of 'this year', but in reality this was not new as it just reflects the words Fed Chair Yellen used during the press conference in June. We think this supports our call that the Fed will make an announcement on quantitative tightening at the next meeting in September.

Another change was that it now says that inflation runs below 2% instead of 'somewhat below', which was a smidgen dovish. It is difficult to say whether it is something we should pay a lot of attention to, as we know, based on Janet Yellen's recent testimony to US congress, that the Fed still has faith in the Phillips curve, i.e. the tighter labour market will push wage growth and thus underlying inflation higher eventually. Due to the Fed's strong belief in the Phillips curve and given we expect a further tightening of the labour market, we think the Fed will hike one more time this year in December. Consensus is for another hike this year, while markets price in a 40% probability.

However, in our view, the jobs report for June highlighted the Fed's dilemma and we still think risks are skewed towards the Fed pausing its hiking cycle due to low inflation, which may not be just 'transitory' given the low inflation expectations. In our view, the problem is that the tightness of the labour market is not the only factor determining wage growth, as second-round effects after many years with low inflation have hit wage growth. When employees expect inflation to remain low, they can live with low wage growth, as real wage growth may still be solid, making it less likely inflation will reach the target (see also Strategy: Central banks consider leaving the party, 30 June). In this regard, it is interesting that four FOMC members indicated that they do not expect the Fed to hike more this year in the June projections.

EUR/USD initially bounced back above 1.17 and yields on US government bonds fell 3-4bp across the curve after the minor dovish twist in the FOMC statement. Over the past month, EUR/USD has indeed witnessed a kind of perfect storm with ECB communication and the balance of political risks shifting in favour of the euro, and with today´s FOMC statement, relative monetary policy should also be less of a downside risk factor for EUR/USD in the near term. On 25 July, we revised our EUR/USD forecast higher and here we pencilled in even more upside to the cross longer term. In the near term, we target EUR/USD at 1.17 in 1-3M, reflecting that we expect the recent level shift higher in EUR/USD to persist, while momentum is expected to ease near term amid stretched technicals, short-term valuations and positioning (IMM). Longer term, we still expect EUR/USD to trade higher targeting 1.22 in 12 months driven by fundamentals and less Fed-ECB divergence. See FX Strategy: more upside for EUR/USD in store, 25 July, for more details.

• FOMC keeps target range policy rate unchanged at 1 to 1.25%year
• Risks to economic outlook roughly balanced; No change in assessment inflation
• FOMC confirms its desire to gradual tighten policy, if situation evolves as expected
• Tapering balance sheet to start 'relatively soon' (instead of this year)
• No noticeable other changes in statement and no dissenters
• US Treasuries rally, dollar is sold and equity stabilize

FOMC keeps policy unchanged

The FOMC statement met market expectations that its policy setting would remain unchanged. The Fed prefers to take decisions at meetings where new forecasts are available and a press conference is scheduled. This means March, June, September and December. Given thin markets, especially the July meeting isn't an appropriate time to surprise markets or implement new measures.

Balance sheet tapering to start soon

The July statement was almost identical with the June one (when rates were increased). The only change worth mentioning concerned the start of the tapering of its balance sheet. In June, the FOMC said it would do so in 2017 provided the economy evolved broadly as expected. Now, it stated: ' The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated. We think that the official announcement will be made at the September meeting and the implementation to start on October 1.

No particular concern about inflation

Following four months of slowing inflations, markets looked closely to eventual changes in the statement about the inflation outlook. Some time ago, Yellen said it was largely due to temporary factors. That assessment is very much open to debate and a few governors already expressed concerns about it and said they preferred to take a pause in the tightening cycle to see how inflation would evolve.

The changes in the statement on inflation were marginal though. In its description of recent developments (first paragraph), the statement mentioned that headline and core inflation had declined and are running below 2%. In June, the statement mentioned that they were running somewhat below 2%. On the outlook, there was no change: 'Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term.' and ' The Committee is monitoring inflation developments closely'.

FOMC expects further gradual tightening

'The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate' but is watching inflation developments carefully. 'The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.' 'The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate.'

Summarizing, we expect the Fed to start implementing its balance sheet tapering after the September meeting. That gives them the opportunity to keep rates unchanged in September and defer an eventual rate hike to the December meeting, if economic conditions remain good and especially if inflation doubts subside. A potential hurdle to start tapering might be the stand-off in Congress over raising the debt ceiling that may reach its zenith end September-half October.

Market reactions not so subdued

Despite the lack of much new info, the Treasury and FX markets reacted substantially in a dovish fashion. US Treasuries went up and erased Tuesday's sell-off losses, while the dollar was sold. The T Note future rose from about 125-21 to 126-02. The curve sifted lower by 3 (30-yr) to 7 bps (5-yr). The outperformance of the 5-yr suggests that the market considered the statement as relevant for the outlook of monetary policy. EUR/USD rose from 1.1640 to 1.1735, setting a new cycle high and threatening key resistance at 1.1736 (38% retracement). USD/JPY fell to 111.20 from 1.1190. Equities couldn't choose a distinct direction

After blowing through double top resistance, EUR/JPY has continued higher on fundamentally driven Euro strength.

I don't normally go as wide as the weekly chart, but higher time frame levels are the same no matter what time frame you view them on and this one is no different. Take a look at the weekly EUR/JPY chart below:

EUR/JPY Weekly:

As you can see, the price of EUR/JPY has returned to quite the significant zone. Just take a look at all the markers that I've placed on the chart.

Literally years and years of touches on both sides of the line. Also significant is the fact that each of the breakouts have been swift. Look at the full candle bodies when the line has been broken. This means that it takes something to make the level snap.

Now zoom into the intraday chart and let's take a look at the price action that we're now seeing:

EUR/JPY 4 Hourly:

Price is respecting the level on an intraday basis too, but those higher highs mean that price is coiling for a possible break higher.

Just keep in mind that EUR/USD is breaking out of higher time frame resistance and momentum is strong.

FOMC Fallout

The Fed has articulated its concerns about the low level of inflation in the US, which lessens the likelihood of a December rate hike. The US dollar then dropped against the other major currencies in a lively afternoon New York session on Wednesday.

As expected, The Feds tipped their hat to the widely telegraphed September balance sheet reduction timing, but it was the subtle downgrade in inflation language which the markets pounced on leaving the December rate hike camp perched precariously. But realistically, after four consecutive misses on US CPI, the writing was on the wall.

Now traders are left mulling over how to deal with the greenback going forward knowing there’s a lot of important data to deal with between now and December. Some are resisting the temptation to not to over react to a Fed that was not supposed to be this dovish, but this price action is too hard to ignore.

EURO

The Euro sprang to life taking out the key 1.0715 Euro’s strength continues to be the market focus, and while we’ve stalled out a bit in Asia unless there’s some re-inflationary signal from Friday’s GDP/PCE, it’s hard to envision any support for the greenback near term. Which would suggest the path of least resistance is higher EURUSD From the 1.4 move, down to 1.0341). Where to from here?

G-10 Complex

Everything else has reacted as expected with the both the KIWI and Aussie taking flight

Outside for the FOMC

The US Senate vote to repeal Obamacare failed. So back to headline watching to see whats next.

WTI nearly hit $49.0 on the back of inventory data providing an underpin to the commodity complex.

The Canadian dollar rose on Wednesday after the Federal Open Market Committee (FOMC) statement kept interest rates unchanged as expected. The biggest highlight of the Fed’s communication was the addition of “relatively soon” to the timing for the start of the central bank’s balance sheet reduction. The September FOMC meeting is seen as a likely candidate to begin trimming the portfolio of assets accumulated during the quantitive easing program.

Weekly US Inventories Fall More than Expected

Oil prices jumped close to 2 percent after the release by the Energy Information Administration (EIA) of the weekly US crude inventories. Oil stocks fell by 7.2 millions barrels, gasoline by 1 million barrels and distillates by 1.9 millions barrels. The larger than expected drawdown pushed oil prices higher as US production is starting to slowdown and the Organization of the Petroleum Exporting Countries (OPEC) and Russia are not backing down in their plans to extend production cuts to reduce the global oil glut.

Fed Remains Optimistic But Concerned About Inflation

The U.S. Federal Reserve tweaked the language on its July FOMC statement from the one published last month regarding inflation. A slight downgrade was evident as the Fed removed the “somewhat” when talking about inflation declining. The other major change was a big signal toward the balance sheet reduction to start in September. Overall there was nothing new for the market and the downgrade on inflation was seen as dovish which is the main reason the USD is on the back foot across the board. Political uncertainty in Washington is not doing the dollar any favors as the healthcare reform debate continues with low probability of a definite outcome.

The USD/CAD lost 0.241 percent in the last 24 hours. The currency is trading at 1.2482 after a dovish FOMC statement was delivered earlier today. The July FOMC meeting did not include a press conference which meant that the document at the end of the meeting was all the central bank would share with the market. The language remained almost unchanged, adding very little to the already known and well telegraphed plans of balance sheet reduction and a potential rate hike later in the year.

The loonie rose against the US dollar as economic indicators in Canada have proven the economy is on a solid path of growth, while the US fundamentals continue to be mixed while also adding the political turmoil surrounding the Trump administration. The Fed has been the biggest supporter of the dollar ever since the market has priced out a Trump bump this year as pro-growth policies promised after the President’s victory are yet to arrive.

The Canadian currency is at a two year high versus the dollar ahead of Friday’s monthly GDP numbers for Canada and the US first estimate of second quarter growth. The loonie rally faces few obstacles unless economic indicators start to soften and the US shakes off the cloud of political uncertainty along with a better than expected GDP.

The price of oil gained 1.838 percent on Wednesday. West Texas Intermediate is trading at $48.54 after the USD retreated following an uneventful Federal Open Market Committee (FOMC) statement published by the U.S. Federal Reserve and a larger than expected drawdown in US weekly crude stocks.

The 7.2 drawdown in weekly inventories was higher than analyst expected with the API report a day earlier also showing a fall of 10.2 million barrels. The comments from US producers about the lack of revenue at current price levels forcing them to cut capital expenses has also driven prices higher as US output is not expected to keep pace against the OPEC led agreement cut in supply.

The price of WTI is near an 8 week high after the OPEC and the other producers who joined the production cut agreement appear to have more stamina than US producers. Risks remain in particular around compliance levels as deeper cuts or even maintaining the current output might be unsustainable for members of the agreement. Already Ecuador and Venezuela have pleaded their case to OPEC. Libya and Nigeria are still exempt from the deal given their latest disruptions caused by geopolitical issues.

Relations within the OPEC are also fragile with Iran and Saudi Arabia on opposite sides of an ideological dispute with other producers taking sides or being forced to like Qatar. Iraq has also hinted that they could increase production but no more details have been shared after the meeting in Russia. Saudi Arabia promised a more stringent compliance regime to assure output limits are enforced.

Market events to watch this week:

Thursday, July 27
8:30 am USD Core Durable Goods Orders m/m
8:30 am USD Unemployment Claims

Friday, July 28
8:30 am CAD GDP m/m
8:30 am USD Advance GDP q/q

Highlights:

• The target range for the fed funds rate was left unchanged at 1.00-1.25% as expected.
• The Fed's characterization of the economy was almost entirely unchanged: growth has been moderate with household spending and business investment continuing to expand.
• The recent decline in both all items and core inflation was noted and inflation is expected to continue running below 2 percent in the near term. Chair Yellen has previously attributed some of the slowing to transitory factors.
• Near-term risks to the outlook were again characterized as "roughly balanced."

Our Take:

Expectations for this week's meeting were low and the Fed delivered on that with no rate change and a policy statement that was very similar to June's. The sole development was a change in language on balance sheet normalization though that was not a surprise. The Fed is now indicating that the planned change in their reinvestment policy, which was outlined in June, will begin "relatively soon." We think today's guidance sets up for tapering to be announced in September and implemented in October. The pace of tapering laid out by policymakers is gradual but nonetheless we think the Fed will want to see how the market reacts. As such, we look for interest rates to be held steady once again in September, breaking the recent trend of one hike per quarter. Holding off on further rate increases until later this year will also give the Fed some time to evaluate inflation developments. We think the Fed will want to see some evidence that tight economic and labour market conditions are actually feeding through to higher prices before going too far toward normalizing interest rates.

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

The Fed's views appear to have changed very little from the mid-June meeting round, with only minor wording changes in the policy statement. 

The Committee upgraded its view of the labor market, removing the previous reference to a moderation in hiring, instead highlighting that job gains have been "solid." Household spending and business investment were also viewed as having expanded. 

The Fed had previously communicated that overall inflation declined and the core metric was running "somewhat below" 2%.This wording was changed, with both the overall and core metrics viewed as having declined in today's statement. Moreover, the FOMC removed the "somewhat" qualifier, suggesting that the magnitude of the divergence from target is greater.

The Fed changed its forward guidance on policy, indicating that it will keep reinvesting MBS and rolling over Treasuries "for the time being," expecting the normalization program to start "relatively soon." No new details on this were provided above and beyond what was communicated in the Addendum in June. 

This was a unanimous decision, with Kashkari (FRB Minneapolis) voting with the Committee once again, after dissenting in June.

Key Implications

There was not much here to work with as far as clues to Fed thinking with the Committee only tinkering with the words a bit.

The Fed's take on the economy appears relatively sanguine, with the current momentum seen as improved after some moderation earlier in the year. However, the Committee's views of inflation took a dovish turn, with the Fed acknowledging that both headline and core metrics have declined and are no longer running just "somewhat" below 2%.

Having said that, the Fed does not appear to be willing to alter its plans, at least as far as balance sheet normalization is concerned. The statement's wording that reinvestments/roll-overs will only continue "for the time being" with balance sheet run-off expected to start "relatively soon" suggests that the Committee is readying to initiate balance sheet normalization at its September meeting, with the run-off starting the following month.

Dollar bulls are clearly unhappy with the FOMC statement today. Fed kept target range for the federal funds rate at 1 to 1.25% as widely expected. The new FOMC statement was almost a carbon copy of the May's one. The exceptions are firstly, Fed indicated that it will start the "balance sheet normalization program relatively soon". Secondly, Fed took the part that "job gains have moderated" and just described that "job gains have been solid". It's clear that markets are taking the message that Fed is going to announce the plan to shrink the balance sheet in September. And Fed will hold it cards for another rate hike till December to see how the economy evolves.

At the time of writing, USD/CAD has already breached this week's low to extend recent down trend. Strength in oil price after inventory data is certainly a factor Key focus will remain on 1.2460 major support. We stay cautious on strong support from this level to bring rebound, considering loss of downside momentum as seen in bullish convergence condition in 4 hour MACD. But sustained break of 1.2460 will pave the way to next medium term fibonacci level at 1.2048.

Despite the strong rebound since making a low at 110.61 on Monday, USD/JPY was held well below 112.41 resistance. Near term outlook remains bearish. Break of 110.61 will affirm our bearish view that recent fall from 118.65 is still in progress for another low below 108.12, possibly to next medium term fibonacci level at 106.48.

At the time of writing, EUR/USD is still limited below 1.1711 temporary top. But overall outlook stays bearish with the pair kept well above 1.1444 resistance turned support. We'd expect a break of 1.1711 to extend recent rally to 1.2 handle.

Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending and business fixed investment have continued to expand. On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

For the time being, the Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated; this program is described in the June 2017 Addendum to the Committee's Policy Normalization Principles and Plans.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.