The Daily Update - Fed, Middle East, Qatar

As widely expected the Fed increased the Fed Funds rate by 25bp to a 1.00%-1.25% range last night with a 9-1 vote; Minneapolis Fed Chairman Kashkari dissented in favour of unchanged rates.

The central bank noted that inflation ‘has declined recently’ adding that, while the risks to the economic outlook remain roughly balanced, the 'Committee is monitoring inflation developments closely.' The labour market is said to have 'continued to strengthen', and that job gains 'have moderated but have been solid, on average.' The Fed also left its ‘dot plot’ medium expectations unchanged until 2018, moving 2019 slightly lower.

In terms of the economy, GDP forecasts were left virtually unchanged and expectations for unemployment revised slightly lower as was the PCE deflator forecasts for 2017; with the core down to 1.7% from the previous 1.9%.

In regard to the balance sheet there were more details than expected given as the Fed‘s ‘caps’ for the monthly portfolio runoff will be set at $6bn in Treasuries and $4bln in MBS. These caps will be increased in quarterly increments of $6bn/$4bn until they reach $30bn/$20bn, where they will be held until further changes are announced. We still do not have a start date but the market now expects a September announcement. In a post meeting press conference, Chair Yellen, said the plan could be implemented 'relatively soon.' adding that the unwind will likely be completed 'a few years down the road', however, she stated that she could not comment on what the longer-run level of the balance sheet is expected to be.

The bond market tone was set earlier in the day with dismal retail sales at -0.3% against expectations for no change, and CPI was down from 1.9%yoy to 1.7% in May, which saw US Treasuries rally into and post the Fed announcement with 10-year yields closing at 2.13% from 2.20% yesterday morning.

As a side point, retail sales is a rather strange series as it accounts for 40% of household consumption, however, it does not follow that weakness in the series can be used to forecast GDP.  Retail sales were stronger in Q1’17 than in the final quarter of last year, but household consumption was up nearly three times more in Q4 than in Q1. This could explain why the Atlanta Fed GDPNOW forecast moved from 3% to 3.2% yesterday on weaker headline data.

Elsewhere, in the Middle East, Qatari bonds continue to rally with the government bonds at the longer-end of the yield curve just one point lower from end of May levels, taking them to a rally of 3 points since the 9th June lows. This bounce in prices is across the curve as the market is relieved there has been no escalation in the conflict in the region, and although the news flow is limited the general feeling is that a negotiated settlement is best for all parties. It also appears that all concerned parties just want a face saving way out. Kuwaiti rulers are the chief negotiators having stayed out of the dispute and are reported to be edging towards a resolution.