Daily Commentary BY THE CURVE TEAM –

FOMC Stays True to Their Word

20th of December, 2018

The US Federal Reserve disappointed many people, including the US President, by delivering a rate hike as expected. The Fed Chair confirmed there is more to come in the year ahead while also making some interesting comments on the outlook.

Chairman Powell and his colleagues on the FOMC stayed true to their word and delivered a rate hike taking the target range to 2.25-2.50%. The updated dot plot from Federal Reserve members still suggests a further two rate hikes next year with one more in 2020. This is down from 3 further hikes in 2019 which is reflective of growing uncertainty in the outlook stemming from softening data, mostly outside of the US.

The market didn’t react well to the initial announcement and short accompanying statement as many were hoping for a more dovish rhetoric. Things only got worse when the Fed Chairman appeared at the press conference shortly after.

One of the key questions was around the outlook and specifically the Fed’s balance sheet. While the dot plots clearly suggest a pause in the normalisation of monetary policy in the US is coming, it will only be a pause in the adjustment of the Fed funds rate.

Powell confirmed that the run down in the Fed’s balance sheet would continue, stating that it was on auto pilot. He indicated that the Fed will use the Fed funds rate as its primary tool and make necessary adjustments as required to facilitate the running down of the balance sheet.

That fact that the Fed won’t slow the pace of running down the balance sheet, even if it stops hiking rates shook the market further. The post press conference losses for many markets, including equities and risk currencies such as the Australian dollar, were larger than the losses immediately after the announcement.

So what we have is a FOMC that won’t be swayed by short term swings in sentiment and markets, or presidents, throwing a tantrum and will remain pragmatic about considerations for monetary policy. That means if the data warrants it, they will continue to normalise policy but won’t be beholden to a prescribed path.

David Flanagan

Director - Interest Rate Markets