In case you missed it, the Fed released its latest press statement on monetary policy yesterday, which caused the Greenback to tank hard as a result. And if you’re wondering what’s up with that, then here are the key highlights from the July FOMC Statement that you should know about.
1. Unanimous decision not to hike
The Fed voted unanimously not to hike this time around. This is not that surprising, though. As noted in my trading guide, the Fed usually makes its move when it releases a fresh batch of economic projections and when there’s a scheduled presser and it just so happens that there weren’t any this time around.
The Fed gave its assessment of inflation as follows (emphasis mine):
“On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.”
This is a bit more downbeat compared to its assessment during the June FOMC statement when it said that inflation is only “running somewhat below 2 percent.”
And remember, Yellen said during the June FOMC presser that “the recent lower readings on inflation, have been driven significantly by what appear to be one-off reductions in certain categories of prices, such as wireless telephone services and prescription drugs.”
However, I noted in my most recent U.S. Economic Snapshot that the headline reading for the PCE price index (the Fed’s preferred measure for inflation) rose by 1.44% year-on-year in May, which is the weakest reading in six months. Moreover, it’s still some distance away from the Fed’s (downgraded) 2017 forecast of +1.6%.
Worse, the core PCE price index rose by 1.39% year-on-year, which is the poorest reading in 17 months and is veering away from the Fed’s still optimistic (downgraded) forecast of 1.7%.
I also mentioned that the annual reading for the core PCE price index has been trending lower for four consecutive months as of May. Furthermore, things may get worse for the PCE price index since the core readings for CPI eased slightly further in June.
As such, there appears to be weakness in underlying inflation so Yellen’s statement that the recent weakness in inflation was due to “one-off” factors appears to be mistaken, which is likely why the Fed’s assessment was slightly more downbeat.
Do note however, that despite the recent weakness in underlying inflation and the Fed’s slightly more downbeat assessment, the Fed’s outlook on inflation remains unchanged, so the Fed still expects inflation to “remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.” Also, “Near-term risks to the economic outlook appear roughly balanced.”
3. Balance sheet unwind “relatively soon”
I already detailed the Fed’s plans for unwinding its balance sheet in my write-up on the June FOMC Statement, so read up on that here or read the Fed’s official Policy Normalization plans here, if you need the details.
The simplified version of it, however, is that the Fed will allow a set amount of its bond holdings to mature. And only the principal payments beyond the set amount would be reinvested. After that, the set amount would be raised every three months until it reaches a predetermined level.
Anyhow, the Fed said in its July press statement that (emphasis mine):
“For the time being, the Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated.”
The addition of phrase “For the time being” as well as replacing “this year” with the phrase “relatively soon” heavily implies that the Fed will be pushing through with its plans to trim its balance sheet.
And market analysts are interpreting those changes to the Fed’s language as a hint that the Fed will start trimming this September.
Not all that surprising, though, since I also pointed out the possibility that the Fed may change its language on its plans to trim its balance sheet in my trading guide.
The Fed’s more downbeat assessment of how inflation has been playing out, as well as the Fed’s stronger language on its plans to trim its balance sheet, caused odds for December rate hike to weaken from just above 50% before the FOMC statement to settle at 46.8% after the FOMC statement, which is very likely why the Greenback sold off across the board.
And if you’re wondering why trimming the Fed’s balance sheet made market players doubt the feasibility of future rate hikes, then just know that trimming the Fed’s balance sheet would mean less buying pressure on U.S. bonds.
And less buying pressure on bonds means that bond yields will likely rise eventually, which would then mean higher borrowing costs.
In other words, trimming the Fed’s balance sheet has a similar effect on borrowing costs as a rate hike.