Global Daily – Fed dials back the dovishness a notch

by: Bill Diviney

Fed View: Powell points to ‘transient factors’ as driver of inflation weakness – The FOMC kept the target range of the fed funds rate on hold today, though in a technical move, it lowered the IOER by 5bp (see below). The statement upgraded the language on recent economic activity, which it said ‘rose at a solid rate’ (previously ‘had slowed’), while acknowledging the slowdown in consumption and investment in Q1. In the press conference, Chair Powell also sounded less concerned about global risk factors such as the slowdown in China and Europe, the risk of a disorderly Brexit, and China-US trade tensions. However, the Fed also noted that both core and headline inflation ‘declined and are running below 2%’ in its statement, and this is something Powell was repeatedly questioned on during the press conference. While stating that the Committee would be ‘concerned’ with inflation persistently below target, he also said ‘we suspect some transient factors may be at work’, and reiterated the expectation that inflation would return to 2% over time. US yields rose following the remarks, suggesting the market expected a more dovish interpretation of recent inflation data. While there were indeed some special factors depressing inflation in the March print, we note that core services inflation has been remarkably stable in recent months, despite a tight labour market and a pickup wage growth. As we discussed in our FOMC preview, this is unlikely to lead to a near-term policy response, but should relatively muted inflation persist into next year when the Fed completes its policy framework review, it does raise the risk of a rate cut later in 2020. Our base case continues to be the Fed keeping rates on hold through our forecast horizon to end-2020.

A technical cut to the IOER, and balance sheet composition discussions – As we had flagged last week, the effective fed funds rate has drifted close to the top end of the target range of 2.25-2.50% in recent weeks, and this prompted the third technical adjustment to the IOER, which was reduced by 5bp to 2.35%. As expected, Chair Powell stressed that this had no bearing on the stance of monetary policy, and was purely to better anchor the fed funds rate within the target range. Powell also announced that the FOMC had a preliminary discussion on the future maturity composition of the balance sheet, now that the normalisation of the balance sheet is due to end in September. At present, the composition is weighted towards the long end of the curve relative to outstanding Treasury issuance (historically, the balance sheet was tilted more towards the short end). The discussion today ‘laid the groundwork for more complete analysis and discussion’ and the Fed will return to the topic towards the end of the year. (Bill Diviney)