The Daily Update - The Fed, as Expected

As expected the Fed left the fed funds target range unchanged at 1.75-2%. The decision was unanimous with a few wording changes to the statement reinforcing an improved growth outlook. There was no press conference post this meeting and the minutes are likely to be of more interest. The market is looking for another 25 basis point increase at the 25-26 September meeting.

The main changes to the statement were an upgrade to the growth outlook stating ‘economic activity has been rising at a strong rate’ when the previous statement had talked of a ‘solid rate’. This statement also noted: ‘Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly.’

The June FOMC minutes had stated: ‘Many noted that, if gradual increases in the target range for the federal funds rate continued, the federal funds rate could be at or above their estimates of its neutral level sometime next year. In that regard, participants discussed how the Committee’s communications might evolve over coming meetings if the economy progressed about as anticipated; in particular, a number of them noted that it might soon be appropriate to modify the language in the post-meeting statement indicating that “the stance of monetary policy remains accommodative.”’ The July statement retained this wording but any continuation of this discussion is likely to be an area of interest in the July minutes, particularly with another rate rise expected in September. Plus, further discussion about the impact of tariffs on the economy after a wording change to a more positive growth outlook.

Jerome Powell had noted in his July 17 address to Congress that gradual rate rises were expected ‘for now’. Inflation data remains supportive of a cautious approach by the Fed: earlier in the week the US PCE deflator for June rose 2.2% yoy which was slightly below market expectations of a 2.3% yoy increase. However, further rate increases will also come at the same time as the Fed’s balance sheet normalisation program ratchets up to USD50bn per month of Treasury and Agency securities in October. Added to this, the Treasury’s funding schedule into the end of the year looks onerous with USD769bn of net borrowing expected in 2H’18 to fund the ballooning US fiscal deficit as a result of tax cuts and spending: the deficit is heading to exceed USD1tn by 2020. We view fiscal expansion at this stage of the cycle as adding to the risks.

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