STORY: The Federal Reserve raised interest rates on Wednesday for the second time in three months, citing continued U.S. economic growth and job market strength, and announced it would begin cutting its holdings of bonds and other securities this year.
The decision lifted the U.S. central bank's benchmark lending rate by a quarter percentage point to a target range of 1.00 percent to 1.25 percent as it proceeds with its first tightening cycle in more than a decade.
The Fed gave a clear outline on its plan to reduce its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.
KRISTINA HOOPER, GLOBAL MARKET STRATEGIST AT INVESCO LTD IN NEW YORK
“This is what I expected – that the Fed would be in something of a hurry to get out plans for balance sheet normalization in advance of any changes in FOMC membership, but that we likely won’t see the start of implementation until the fourth quarter. And as I expected, the Fed will be slowly and carefully normalizing. What’s perhaps most noteworthy is that the Fed has taken its data dependent monetary policy with regards to the fed funds rate and extended it to balance sheet normalization – note the sentence in the Addendum to the Policy Normalization Principles and Plans:
MICHAEL PURVES, CHIEF GLOBAL STRATEGIST AT WEEDEN & CO IN NEW YORK
"When you look at the Fed statement and you think about how the recent data has been trending and you think about the market reaction, the core question is does the Fed really change their narrative aggressively. Not today so much but do we start seeing a much more dovish narrative going forward? Because it's going to be really hard to defend some of the things that they have put in this statement, if in fact the data doesn't start getting better soon.
"A couple of weeks ago (Fed Governor) Lael Brainard gave a speech that was very much of the view that we are not seeing the inflation necessary to really talk seriously about a balance sheet reduction any time soon. That, sort of more fringe narrative, is going to go mainstream.
JOE MANIMBO, SENIOR MARKET ANALYST, WESTERN UNION BUSINESS SOLUTIONS, WASHINGTON
“The U.S. dollar cut session losses after the Fed raised rates... and signaled another rate increase before the end of the year. Ahead of the Fed’s decision, the broadly weighted U.S. dollar index had fallen to fresh lows for the year after disappointing news on the U.S. economy cast doubt on further rate increases. While the Fed noted the recent slowing in inflation that was evident in today’s consumer price index, the bank’s forecasts for the economy maintained confidence in its underlying strength. The Fed revised up slightly its forecasts for growth this year while it nudged down its predictions for unemployment and inflation. The Fed chair’s comments at the bottom of the hour are also likely to impact currencies. The Fed’s glass half full assessment of the U.S. economy should support the dollar. But if the Fed’s view should prove overly optimistic the dollar would be at risk of deepening its recent losses.”
HEIDI LEARNER, CHIEF ECONOMIST, NEW YORK, SAVILLS STUDLEY, SAVILLS PLC
“The market should take confidence in the fact that they’re being very transparent in setting clear policy steps in terms of how they normalize the balance sheet. Certainly more transparency is a good thing.
“After this morning’s dip in CPI to 1.7 percent from 2.3 percent year on year at the beginning of the year, it would be hard for them not to adjust that down, the same thing about their changes to the unemployment rate, the dip down for 2018, 2019 has to reflect the fact we’re already at 4.3 percent.
“I would have liked to see some mention about the extent to which they’re concerned about the decline in inflation. That’s probably behind Kashkari’s dissent in terms in wanting to keep rates where they were, but they didn’t seem terribly worried.
“If you look at the fact that now we’ve had two rate hikes this year, you could argue we’ve gone from 2.6 percent in 10-year Treasuries, now down to almost 2.10 percent, so that 50 basis points increase we’ve had in Fed Funds has been equal to the decline in 10-year Treasury yields. So clearly the flattening of the yield curve here suggests maybe not as much growth or not as much tightening as would have been the case.
BRETT RYAN, SENIOR U.S. ECONOMIST, DEUTSCHE BANK, NEW YORK:
"The fact that they kept the interest rate trajectory the same is not surprising. Despite the weak inflation prints recently they are not reexamining or rethinking the path of rates just yet. We did get more details than expected on reinvestment tapering but they were in line with what we were expecting.
"They upgraded their level of concern about inflation by stating that the committee is monitoring the inflation "closely." To the backdrop, they lowered inflation forecasts in the summer of economic projections by 0.3 pct in the headline and 0.2 percent in the core. That sets a low bar to get to their forecast target by year-end. As long as your core PCE is on track to hit 1.7 percent, market participants should expect another rate hike by the end of this year.
"In terms of our forecast, nothing really has changed. We still think in September they take a pause. They announce implementation of taper. They could hike at that time, but we think they probably pause then and then hike in December assuming things go well.
"They did a good job communicating.
"The market is still underpricing 2018 and 2019 well below where the Fed thinks things are going to be in terms of rates.
MARK CABANA, HEAD OF U.S. SHORT RATES STRATEGY AT BANK OF AMERICA MERRILL LYNCH IN NEW YORK:
“I don’t think that there is really too much new in here outside of the fact that the Fed remains committed to the slow gradual normalization process despite some of the weak data that we’ve had. It just looks like the Fed is sticking to their story and the market remains highly skeptical that the Fed is going to be able to deliver just based upon underlying data. I would think that at some point the market is going to be pricing in even greater risks that the Fed might be moving too quickly, and we’ve certainly seen some of that price action over recent days with yields falling and inflation breakevens moving lower, but for now it seems like the Fed is pretty committed to stay on their path.”
DAN IVASCYN, GROUP CHIEF INVESTMENT OFFICER AT PACIFIC INVESTMENT MANAGEMENT CO, NEWPORT BEACH, CALIF:
“The statement was slightly on the hawkish side. I think it’s just how Central Banks speak. I think that, more important, arguably today was the weakness of the retail and inflation data. As our economist pointed out, there’s a trend and signs of weakening in the harder data. There’s some pressure on inflation and we think the Fed is going to take note of this weaker data. The reality is that they are going to be data-dependent and we remain cautious on interest-rate risk, but we’re not massively selling bonds here. Be careful not to be bearish on this statement.”
BILL NORTHEY, SENIOR VICE PRESIDENT, US BANK WEALTH MANAGEMENT, HELENA, MONTANA
"The muted market reaction thus far I think that’s what is standing out to me.
“Notably as I’m looking down through the adjustments that were made … the PCE inflation expectations for 2017 have been materially ratcheted down from 1.9 to 1.6 percent. That’s notable because that indicates that the Fed is viewing that there’s less inflation in the system and would look at this as a relatively dovish hike.”
“To the extent that this is viewed as a materially dovish hike we could see a little bit more weakness in the dollar.”
“When you’re looking at lower levels of inflation and potentially a Fed that may have to take a somewhat slower path toward policy rate normalization that could allow rates to stay lower for a longer period of time across the Treasury curve and continue to provide more accommodation, things that have been positive from an equity markets perspective. Certainly valuations across the equity market complex are full at this time and aided by low interest rates and low inflation.”
“An interest rate rise today was highly expected and shows the Fed continues to be confident in moving toward normalizing monetary policy. Despite recent underwhelming jobs numbers, the underlying US economic data remains robust enough to warrant tightening.
“While the economy is bouncing back from a weak first quarter, earnings have been strong and even in the wake of continued political uncertainty, corporate confidence remains secure. The market has demonstrated that it is comfortable with gradual rate hikes and will be reassured that the Fed has today committed to its promises. We expect at least one more rate hike this year but incoming data will influence future decisions.”
“The next step for the Fed will be to reduce its balance sheet and stocks could experience bouts of volatility in the coming months due to both political surprises and Fed policy communications. The bull market still has legs, but investors should be aware that risks are elevated.”
BRENT SCHUTTE, CHIEF INVESTMENT STRATEGIST AT NORTHWESTERN MUTUAL WEALTH MANAGEMENT IN MILWAUKEE, WISCONSIN
“This one was priced in by the market and even with the weaker inflation data today everyone still expected the Fed to hike rates because the market had given them the green light to do so. There is a lot of information also to digest in this one with the balance sheet reduction and some slight tweaks to the language. But in general the underlying economic backdrop, in my mind, supports what they did today. The funny thing is the retail sales data was actually decent. Everybody forgets to look at the revisions and if you look at the revisions for the last two months they were actually up quite a bit. So you have retail sales which actually now are additive to second-quarter GDP.
"Everybody is fixated on the inflation data and it is a little bit of a mystery. But in general you are at this point in the economic cycle where unemployment is, where qualified workers are hard to find. The textbook says that inflation should rise, the question is if this time is different. We still believe supply and demand works and because there is not much supply of labor and a ton of demand, wages will rise and the way companies will pay for those wages is through rising prices which will translate to rising inflation in the future.”
RICH TAYLOR, PORTFOLIO MANAGER AT AMERICAN CENTURY INVESTMENTS IN MOUNTAIN VIEW CALIFORNIA
"The big takeaways were as expected. What is noteworthy is that today Yellen laid out the balance sheet reduction plan with a lot more detail."
"Obviously with the big drop off in inflation this morning, which was a bit of a surprise, and the recent softening of economic data in general, it certainly gave the Fed pause with regards to September."
"The market's not reacting much because the 25 basis point increase was widely expected."
"In the bond market we're still range bound. For investors it’s still a yield grab in the credit markets even though the credit markets are very expensive. Bond investors don't have to worry about significantly higher rates for quite a while."
"There's too many headwinds on the economic and geopolitical front to take up interest rates out of the recent range any time soon."
"We still think there's one more 25 basis point move, obviously data dependent but it might not happen until December if we continue to get soft inflation data."
BRIAN JACOBSEN, CHIEF PORTFOLIO STRATEGIST AT WELLS FARGO FUNDS MANAGEMENT IN MENOMONEE FALLS, WISCONSIN
“The FOMC met expectations and delivered a dovish hike. It’s dovish in that they acknowledge the data has softened and they haven’t dismissed the weaker inflation readings as being merely transitory. While the base case can be for another rate hike this year, it’s not unthinkable that they could just pause until September or even December to get the “coast is clear” signal on inflation.
“The balance sheet reduction plan is so mild and mechanical that it shouldn’t be an issue for the longer-dated Treasury or MBS markets. They stormed into the room with QE and are tiptoeing out almost unnoticed.”
GENNADIY GOLDBERG, INTEREST RATE STRATEGIST, TD SECURITIES, NEW YORK
“Generally speaking this does seem like a more hawkish statement. The Fed announcing an update to their reinvestment principles leaves September open (for) the start of balance sheet runoff, and the fact that they haven’t slowed their projected path of rate hikes suggest they can do both balance sheet and rate hikes at the same time.”
STOCKS: Stocks moved slightly higher then flattened. The S&P 500 .SPX was last down 0.2 percent after being down 0.06 percent just before the decision.
BONDS: U.S. Treasury yields briefly fall, then retrace and edge higher.
FOREX: The U.S. dollar index pared earlier losses.
Reporting by Megan Davies