As we approach the Fed rate decision at 7pm (BST) this evening, here are the previews of what to expect from 12 major banks:
We expect the July FOMC statement to hint at an announcement of balance sheet normalization in September. Following the announcement of scheduled caps on runoff and recent Fed guidance about the terminal balance sheet size, we update our balance sheet projections. Our baseline expectation is that runoff will continue until the balance sheet reaches a “large” terminal size in late 2021 of about 13.4% of GDP ($2.6tn today or $3.0tn in 2021). Alternatively, a preference of future Fed leadership for a “small” balance sheet would imply a terminal size of 11% of GDP.
Today’s FOMC meeting looks set to result in the beginning of a nearly nine-month pause in hiking rates. Not hiking rates in July (a non-press conference meeting) would not be surprising, but we expect the pause to persist until March 2018. We continue to expect the Fed to announce its balance sheet unwind in September, since this is less tied to inflation. We believe the reason for a pause in rates is two-fold: 1) weakening inflation will likely force the Committee to wait for more evidence of inflation picking up before making another move on rates; and 2) Chair Yellen appears less comfortable hiking rates ahead of her possible departure (at the end of her term as Chair in February 2018).
The July FOMC statement is out today but it may be one of the more boring Fed releases in a while. There should be only modest adjustments to the characterization of the economic backdrop and we expect no change to the policy language. While some have speculated that the Fed could announce the start date of balance sheet run-off in this press statement, the Fed has been loath to make potentially market-moving decisions in a non-press conference meeting. Some expect the language on inflation to change – we think that is also unlikely (it is cautious enough for the Fed to stick with it for now).
The FOMC Meeting take centre stage today, and while analysts at Societe Generale expect few major changes, all eyes will be on whether the Fed announces the start of its balance sheet normalization policy. The highlight of the meeting will be whether or not the Fed decides to announce a start date for balance sheet normalization. We lean towards the Fed making the announcement at the September meeting, with an October start date, as it will give Chair Yellen a chance to explain the Fed’s reasoning at her press conference, something that will not accompany the July meeting. In addition, the June FOMC Minutes revealed an ongoing debate about the timing of the announcement, with some officials preferring to wait a couple of months. Thus, we suspect that the Fed will opt to alter the language in the paragraph on the balance sheet, noting that it will begin “relatively soon,” thus confirming market expectations for a September announcement. In terms of other changes to the statement, we look for only minor tweaks.
By definition, the Federal Reserve Open Market Committee meeting is the highlight of the day. Without a press conference and following last month’s rate cut, there is practically no chance of a new policy initiative either on the balance sheet or the Fed funds target. Market participants will be most sensitive to how the FOMC statement discusses inflation. There has not been sufficient data to require a significant change in the Fed’s statement. The Fed can show patience. There is no rush. After declining from February through May, core inflation needs to not only stabilize, as core CPI did last month. It needs to rise for perhaps a few months before a cautious central banker may feel confident that the soft patch has passed.
The Fed is universally expected to leave rates unchanged at the July FOMC in what could serve as a placeholder meeting as policy makers await confirmation that disinflationary headwinds are transitory. Our base case calls for minor mark-to-market changes in the statement while a more cautious message on inflation would warrant a more dovish reaction. One other risk is that the Fed uses the July FOMC to explicitly set up balance sheet reduction starting in September, which would be viewed as hawkish. We expect the Fed to start shrinking its balance sheet in September, but do not expect a pre-announcement in July. There is a modestly hawkish risk the FOMC signals a change “relatively soon” or “at an upcoming meeting” in the FOMC statement. Fed speakers have sounded a bit more cautious on the inflation outlook, but a significant change in tone is unlikely, in our view. Some softening of the inflation language is a dovish risk, however.
We expect the Fed to stay relatively upbeat this week, despite mixed economic data of late. But markets will be particularly interested on the Fed’s thoughts on recent sluggish inflation readings, which has caused a large divide between the Fed’s rate hike projections (four hikes by the end of 2018) and market expectations (who are barely pricing one). We suspect the next hike won’t come until December, whilst the Fed keeps an eye on recent inflation developments. We’ll also be watching closely for any fresh hints on the timing of balance sheet reduction (we think this will be announced in September for an October start). Looking further ahead, we are still forecasting two Fed rate hikes in 2018, with recent comments on asset price valuations and loose financial conditions suggesting Fed officials are broadening out their reasoning for tighter monetary policy.
A change to the target range for the federal funds rate is highly unlikely, only one month after it was raised to 1.00-1.25%. For now, the FOMC may continue to indicate that it intends to stick to its plan to hike three times this year, but if inflation continues to undershoot the Fed’s target and expectations, the doves are likely to gain ground in the Committee. In addition to clues about the Fed’s take on inflation and its implications for the next rate hike, the markets will be focused on clues about the Fed’s balance sheet. In fact, the FOMC expects to begin implementing its balance sheet normalization program ‘relatively soon’, provided the economy evolves broadly as anticipated.
Today’s market focus will be on this evening’s US FOMC announcement. While no changes are expected to policy, and the press statement likely to be relatively unchanged from the June meeting, the market reaction to today’s announcement should be fairly muted. However, any shift in tone around the inflation outlook and/or any further hints around the likely starting point for the balance sheet normalisation process could elicit some market reaction.
We expect the Fed to maintain the Fed funds target range at 1.00-1.25% at this week’s meeting, in line with consensus and market pricing. As it is one of the small meetings, all eyes are on the statement, as there are no updated projections and no press conference. Given the Fed seems to act only at the big meetings, we think the Fed will wait until September to make an announcement on ‘quantitative tightening’, despite many FOMC members thinking they should get going ‘relatively soon’. We do not think there will be major changes to the FOMC statement, although it is likely the probability is skewed towards a slightly more dovish tone given inflation has now been weaker than expected for four consecutive months.
We expect no major policy changes or announcements at this week’s FOMC meeting. Chair Yellen’s congressional testimony last week, recent remarks by FOMC participants, and the minutes from the June FOMC meeting all suggest that the Committee will wait to confirm that the economy, including inflation, is on track before raising rates again. We expect the FOMC to announce a decision to start to let the balance sheet roll off after its meeting in September. While we do not expect the FOMC to “pre announce” such a decision this week, it would not be surprising if the statement included some hint that the Committee expects to take this decision at the September meeting. Moreover, we will be looking especially at the language on inflation. During her semiannual testimony before Congress on 12 July, Chair Yellen acknowledged that “the recent lower readings on inflation are partly the result of a few “unusual reductions in certain categories of prices.” On the other hand, she also mentioned “… uncertainty about when – and how much – inflation will respond to tightening resource utilization”— as one of the key risks to the outlook. Following her testimony, on 14 July, core goods CPI inflation for June came in on the weak side again, leaving the question of how much of the recent weakness is transitory still unresolved. Against this backdrop, we think the July FOMC statement may provide some additional nuance on how the FOMC sees the recent underperformance of inflation, although we expect the main message that the FOMC expect inflation to move up to its 2% target over the medium term to be reiterated. Other than inflation, we do not expect the statement’s views on the economy or the economic outlook to materially change.
In their June meeting communications, the FOMC remained resolutely positive on the outlook for the economy. This was principally owing to the strength of the labour market and a belief that, inevitably, this would translate into stronger wages growth and consumption. Their view of business investment was also constructive. A degree of unease however emerged in the minutes, with fiscal policy shifting from a solely positive risk to an either or proposition; the potential negative impact on investment of fiscal impasse was also noted. Since then, some members of the FOMC have also questioned the potential impact of balance sheet normalisation on the Fed Funds Rate path. Absent Q&A and forecasts, the July meeting offers limited scope to provide detailed guidance. But you can expect the statement to contain a positive view to keep the FOMC’s options open, particularly given the market’s sombre view.