Fed gives little indication of interest rate trajectory

The Federal Open Market Committee (FOMC) meeting has come and gone, and little has changed in the financial markets as a direct consequence. In unanimously deciding to keep interest rates unchanged, as widely expected, the Fed made few appreciable changes to the verbiage of its statement from the last FOMC meeting. Overall, the statement was relatively neutral, skewing slightly towards the dovish side, or at least not as hawkish as might have been expected given the recently renewed optimism pervading the US economy and financial markets since November’s US presidential election.

Only two parts of the FOMC statement were of particular note in reflecting the recent optimism, imparting a very subtle hawkish tone: 1) “Measures of consumer and business sentiment have improved of late,” was a new addition that acknowledged increased confidence in the economy. 2) Instead of the previous verbiage that “inflation is expected to rise to 2 percent over the medium-term,” the phrase was changed to “inflation will rise to 2 percent over the medium-term.” This reflected some more certainty that inflation will indeed climb in the new economic environment.

Despite these acknowledgements, financial markets had been bracing for somewhat more hawkish undertones from the Fed that perhaps could have provided some signal of an accelerated pace of policy tightening this year. But there was no signal to be had, as the FOMC statement again reiterated only “gradual increases in the federal funds rate” going forward. In addition, the statement asserted that the committee would maintain its existing balance sheet, giving no indication of when it may begin to unwind its quantitative easing program. This maintenance of its large balance sheet, according to the committee, “should help maintain accommodative financial conditions.”

After today’s FOMC decision, the market-viewed likelihood of a rate hike at the next Fed meeting in March dropped noticeably, reflecting lower expectations that the Fed will step-up its tightening schedule any time soon. The immediate market reaction was rather muted, but reasonable given the slightly lower rate hike expectations. The US dollar fell and gold rose, as might be expected, but the moves were not pronounced. US equity markets initially made a modest spike on the FOMC decision, but quickly settled back into a tight range, heading for a modestly positive close on the day.

With the FOMC out of the way, and little having been learned about the Fed’s outlook in the process, market attention now turns to Friday’s US jobs report, which is expected to show 170,000 jobs added to the US economy in January. The ADP private employment report on Wednesday came in dramatically higher than expected at 246,000 jobs added in January against expectations of only 165,000. Additionally, the ISM Manufacturing PMI on Wednesday was also better than expected, with its employment component showing substantially faster growth in January when compared with the prior month. These pre-indicating data points bode well for a potentially higher than expected showing for non-farm payrolls on Friday.

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