(Reuters) - The U.S. Federal Reserve left interest rates unchanged on Wednesday but signaled it still expects one more increase by the end of the year despite recent weak inflation readings.
The Fed, as expected, also said it would begin in October to reduce its approximately $4.2 trillion in holdings of U.S. Treasury bonds and mortgage-backed securities by initially cutting up to $10 billion each month from the amount of maturing securities it reinvests.
VICTOR JONES, DIRECTOR OF TRADING AT TD AMERITRADE IN CHICAGO
“The equity reaction came on two key points. The first was Yellen’s comments that the risk to the economy were balanced on both sides. It’s a little bit less of a positive statement on the overall economy than we’ve seen in some time. The second thing is the sheer strength in the dollar following the announcement.”
“The Fed coming in and letting these assets mature. It kept the December rate hike on the table. That’s giving some legs to the dollar.”
“Keeping rate hikes where they were was expected. What wasn’t known was the tone. The market is interpreting the Fed as slightly hawkish but not too much.”
“As expected with the spike in yields we’re seeing financials rising.”
LUKE BARTHOLOMEW, ABERDEEN STANDARD INVESTMENTS INVESTMENT STRATEGIST, LONDON:
“The US Federal Reserve has firmly signaled that a December rate rise is still on the table. But it will be hard for investors to put too much faith in this forecast while there is still plenty of time for the Fed to change its mind. Clearly the Fed still believes that lower unemployment will eventually translate into a pick-up in inflation. But if inflation continues to undershoot it is hard to see the Fed following through on a hike.”
TIM ALT, DIRECTOR OF CURRENCIES AND RATES, AVIVA INVESTORS, CHICAGO
“What you are seeing is a reaction to the lower inflation and higher growth and a continued hawkish Fed, but you see a lower terminal funds rate.
”Still this supports higher real yields and a flattener yield curve so that would be dollar supportive. Right now the market sees the Fed more hawkish than anticipated. There was a lot of speculation before the statement that they might pull a third rate hike in 2017 due to factors such as slowdown from the hurricanes. The Fed didn’t back from that view at all. I think this dollar rise could be sustained for awhile. It probably won’t go that much higher because the world is a better place than a year ago. The Fed is not the only game in town. Other central banks seem ready to tighten policy with the economic optimism emerging around the world.”
DAVID JOY, CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL, BOSTON:
”You’re seeing a pretty good reaction in the short end of the yield curve. That to me seems to be at least the early story here, which suggests a lot of people maybe weren’t anticipating the Fed would stick with the third rate hike expectation this year. So there’s a little adjustment going on there.
The dollar looks a little stronger on this news. I wouldn’t expect today’s decision to have too much of an impact on the equity market. I think it’s kind of consistent with the view that the economy is doing OK, and as far as equity investors are concerned, another rate hike is not going to change that view.”
BRIAN JACOBSEN, SENIOR INVESTMENT STRATEGIST, WELLS FARGO ASSET MANAGEMENT, MENOMONEE FALLS, WISCONSIN
”The Fed’s balance sheet will finally be turning a corner. Beginning in October, it will gradually let the size of the balance sheet shrink, but it should happen so gradually that it won’t have a material effect on fixed income yields.
”Based on the projections, the bulk of the members of the FOMC are signaling they’re ready to vote for another hike in 2017. There are two outliers, Bullard and Kashkari, that think the Fed should be done hiking for the foreseeable future, but they’re not going to sway the rest of the committee.
“If people are worried that debt servicing costs could rise over time, then they may want to pay closer attention to investing in companies with clean balance sheets.”
TOM PORCELLI, CHIEF U.S. ECONOMIST, RBC CAPITAL MARKETS, NEW YORK:
”If you want to build the case for why this is hawkish, the path you can go down was that they were dismissive of hurricane impacts, basically saying that it’s going to inflict hardship but net net it’s going to levy a modest negative impact. Maybe the reality is starting to sink in for the market that they really do want to go in December.”
CHARLIE RIPLEY, INVESTMENT STRATEGIST AT ALLIANZ INVESTMENT MANAGEMENT, MINNEAPOLIS
”Today’s announcement definitely is an important milestone for the Fed, obviously making the announcement to begin reducing the balance sheet. But more importantly what investors were trying to pay attention to was really the dot plot. You take a look at 2017’s median dot, it was unchanged. That gives us a little bit more confidence that there is probably going to be a third rate hike coming in December. Taking a look at 2018, that was also unchanged, so three rate hikes are projected for next year. That sends a little bit of a hawkish message to the market that normalization is well underway. It seems that the current Fed is willing to project that forward into the next year.
“There is a caveat to that, there are a lot of seats to be filled within the Fed and the composition could change, especially given that (Chair Janet) Yellen’s term ends in February. So take it with little grain of salt, I guess, but our initial take is that it’s a little bit more hawkish.”
MICHAEL ARONE, CHIEF INVESTMENT STRATEGIST, STATE STREET GLOBAL ADVISORS, BOSTON
“The Fed did a good job telegraphing what they were going to do and then they followed through with it, so I’m not sure the market (had) all that much of a reaction to it. They acknowledged in some of the statement that the hurricanes themselves, although tragic in terms of the personal impact, are not likely to affect the national economy, although they acknowledged that it could affect prices in the short term.”
MOHAMED EL-ERIAN, CHIEF ECONOMIC ADVISER AT ALLIANZ, NEWPORT BEACH, CALIF.:
“The Fed took another step on its path of beautiful normalization, announcing that the gradual balance sheet reduction will start next month and limiting revisions to both projections and policy guidance.”
LARRY HATHEWAY, CHIEF ECONOMIST, GAM INVESTMENT MANAGEMENT, ZURICH, SWITZERLAND
“The market reaction has been subdued, with yields slightly higher. Global fixed income markets will next take their cues from growth and, especially, inflation readings, as well as from guidance from the ECB and the Bank of England about the potential for monetary policy adjustment in the Eurozone and the UK in the coming few months.
”Despite the Fed’s well-choreographed message today, bond yields are apt to rise if inflation accelerates and if central banks appear to be moving in unison to tighten monetary policy in 2018.”
STOCKS: Stocks extended losses slightly, with the S&P 500 .SPX down 0.08 percent, versus down 0.04 percent just ahead of the decision. Financial stocks gained.
BONDS: Benchmark 10-year notes US10YT=RR fell 11/32 in price to yield 2.29 percent, up from 2.24 percent before the Fed’s statement and the highest level since Aug. 8.
FOREX: The U.S. dollar gains, with the dollar index .DXY up 0.7 percent versus down 0.2 percent just before the announcement.