Fed holds rates, signals likely December hike

Today’s much-awaited Federal Reserve (Fed) meeting and press conference came and went with what I’d describe as few surprises. The Fed left the federal funds rate unchanged (target range of 0.25% – 0.50%) but saw three Federal Reserve Bank presidents (Esther L. George, Loretta Mester and Eric Rosengren) cast dissenting votes in favour of a hike.

The statement noted that the labour market has continued to strengthen and that growth had picked up from the modest pace earlier in the year. Additionally, the Fed adjusted its view on risks to their economic outlook, saying that risks had become “roughly balanced.”

The Fed’s Summary of Economic Projections saw a couple of changes at this meeting. The committee made minor adjustments down to its personal consumption expenditures (PCE) inflation projections, but the most-noted changes came to its 2018 potential GDP estimate and 2018 Fed Funds projection. They lowered 2018 potential GDP to 1.8% from 2.0% and also lowered their 2018 Fed Funds projection to 1.9% from 2.4%.

The Fed’s projections have been continuously lowered throughout the economic recovery, as they were proven to be overly optimistic. Only three Fed members are projecting no hike before year-end, and so the Fed seems to agree that one rate hike is likely this year. The market odds of a December Fed rate hike have not moved much since the announcement and still stand at about 60%. In my opinion, the Fed is likely comfortable with that expectation and I believe they will try to manage those expectations prior to future meetings.

There is a Fed meeting scheduled on November 2, but in my opinion it is highly unlikely that the Fed will choose to hike rates ahead of the November 8 U.S. presidential election, unless growth and inflation pick up dramatically in the next six weeks.

At Invesco Fixed Income, we believe that the Fed’s statement should be viewed positively for equity, bond and commodity markets, as the Fed did not take the opportunity to tighten monetary policy. It appears they are continuing to be cautious in this regard. In addition, we believe this should allow the economy to continue improving before the Fed takes its next step – unless global financial conditions tighten unexpectedly. Finally, I think this announcement will be reflected in a weaker-to-neutral U.S. dollar.