As expected, the Fed left interest rates unchanged at its January meeting and the accompanying statement was viewed as having a dovish tilt as it pointed to a pause in the tightening cycle and prompted market debate whether the US rate-hike cycle has peaked. Jerome Powell also adopted a dovish tone in the press conference acknowledging ‘the case for raising rates has weakened somewhat’ and inflation risks ‘appear to have diminished’. He also noted ‘our policy rate is now in the range of the committee's estimates of neutral’ and ‘we think our policy stance is appropriate’. US equity markets rallied in response, Treasury yields edged lower and the US dollar index (DXY) weakened.
Key wording changes to the FOMC statement included removing the comment the Committee ‘judges that some further gradual increases’ in the target range are consistent with sustained economic expansion and its inflation objective and instead stating the Committee ‘decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent’. The statement acknowledged the softening economic backdrop: the description of economic activity was downgraded to rising at a ‘solid rate’ rather than the ‘strong rate’. Plus, the statement removed the comment that ‘the Committee judges that risks to the economic outlook are roughly balanced’. Reflecting the change in conditions and a benign inflation backdrop the statement pointed to the Fed taking a cautious approach to meeting its goals of fostering maximum employment and price stability noting ‘the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.’
The FOMC also issued a statement on the balance sheet normalisation noting ‘The Committee continues to view changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy.’ However, they emphasised a flexible approach to balance sheet normalisation and ‘the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet,’ if it were required.
The shift to a ‘patient’ stance by the Fed should further support US Treasuries and high grade bonds which have rallied strongly over the past 3 months with 10 year yields falling from 3.24% on 8th November down to 2.66% currently. In the short term, tomorrow’s payrolls data will dictate the near term performance but the global economic backdrop suggests that there will soon be a few more canaries entering the coalmine.