The Federal Reserve statement, which was released following its 2-day meeting that ended on Wednesday, contained no big surprises. Still, there were some shifts in the Fed’s language which do provide clues as to what happens next.
The most important point was perhaps that the Fed has upgraded its view of the US economic expansion to “solid” from “moderate”. It also upgraded its view of job gains, describing them as “strong” instead of “solid” in the previous statement. The Fed in addition acknowledged that lower energy prices are helping households. The Fed Governors finally removed the reference to “considerable period” before interest rates rise that had been maintained in the previous statements. All these were positive and hawkish points that favored dollar bulls.
On the negative and more dovish side, the Fed noted the declines in inflation below its 2% target and forecast inflation to decline further in coming months. However, this was mostly due to lower energy prices and the Fed expected inflation to gradually rise back to 2% “over the medium term”. The Fed also showed a degree of concern over “international developments”, which it said would be considered prior to any policy move. The Fed also judged it can still be “patient in beginning to normalize” monetary policy. Therefore, this should put the Fed on hold – at least for another couple of meetings.
The Fed Funds rate target remained between 0 and 0.25% and the central bank would keep reinvesting the principal repayments from its huge bond portfolio of agency, mortgage-backed and government debt.
One development that was probably welcomed by Chair Janet Yellen was that the statement received unanimous backing. This more likely had more to do with the rotation of voting members on the board rather than a change of view by the board members, as the previous statement’s dissenters, R. Fisher, N. Kocherlakota and C. Plosser no longer served as voting members this year.
Euro / dollar fell by around half a cent following the release of the statement, from 1.1330 to around 1.1280. The S&P 500 dropped by nearly 1.5% close to the 2000 level from around 2030 prior to the statement’s release. The market was anticipating a more dovish Fed statement it looked like.
However, the present 0% level of interest rates is probably causing some discomfort to the Fed and they will like to take the opportunity to raise interest rates away from that level the first chance they get. This does not necessarily mean that they will embark on a long interest rate hike campaign, as they will likely wait for inflation to pick up significantly before really starting serious monetary tightening. With oil prices low and inflation around 1.5%, the risk of such a tightening campaign taking place is limited, but one or two quarter-point hikes are certainly possible this year if the current benign financial environment is maintained and the job market continues to improve.