US Watch: The Fed awakens • As expected the Fed hiked rates and emphasized a gradual exit. • The Fed was not as dovish as the rates market had hoped. • While the near term outlook is unclear, we still see the dollar rallying in the year ahead.
The dark side of the hike
The Fed's decision today offered few surprises. They finally stopped vacillating and hiked rates by 25 bp. It was a "dovish hike": the statement, the forecasts and the press conference underscored a gradual pace of hikes ahead. However, as we also anticipated, it wasn't dovish enough to "dovetail" with rate market expectations of only two hikes next year. The dot plot continued to show that the Fed expects to hike by 100bp next year, which is much slower than history but still well above market expectations (Chart 1). At the same time, the statement's more optimistic tone was welcomed by the equity market.
It is hard to hike and "hug" the bond market at the same time. The FOMC statement is directed not only to financial markets but to the American public. The Fed needed to be clear why-after so many years-it is finally hiking. Moreover, we think the Fed would not be hiking unless it expects more to come. If Fed's message is too dovish, it could raise doubts about why they are hiking in the first place.
In our view, there were three key messages in the statement. First and foremost, the Committee is confident about achieving both sides of their dual mandate. Specifically, "the Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective." Second, they recognized "the time it takes for policy actions to affect future economic outcomes." This explains why they are hiking before inflation has actually picked-up. Third, they presented a unified front. Among the voters, three members had expressed reservations about hiking today, but none of the three dissented. Presumably few non-voting hawks did not support the move, but even they conceded some ground by lowering their forecasts for rate hikes next year.
Yellen mind control
The press conference not only gives the Chair a chance to flesh out the statement in more detail, it gives the press a chance to question the decision. This can create an interesting dichotomy where the prepared comments lean in one direction while the answers to questions lean in the other direction. In September, Yellen wasn't able to focus attention on the FOMC's decision as a tactical delay, as many of the questions were about "why didn't you go" and "what has changed in terms of your priorities." In defending why the Fed didn't hike, Yellen ended up sounding very dovish. Now that the Fed finally has hiked, the questions today were variations on "why did you go now"? Yellen thus ended up sounding somewhat more hawkish than her main message of a very patient Fed that intends to raise rates gradually and only as the economic outlook supports further moves.