Ok, so the obviously the most important thing this afternoon is that the Fed still sees one more hike in 2017.
“Connect the dots, la, la, la”…
Here’s Goldman’s quick summary, although if you were following along in real-time, you don’t need it:
The median dots in the Summary of Economic Projections continued to show a third rate hike this year and 3 hikes in 2018; however, the median dot declined for 2019 and is now consistent with just over 2 hikes in that year. The post-meeting statement continued to describe risks to the outlook as “roughly balanced” and added that headline and core inflation “declined this year” and are running below 2 percent. The statement also discussed negative near-term growth effects from the hurricanes, but the committee does not expect them to “materially alter the course” of medium term growth, and the SEP projection for current-year growth was actually revised up. Taken together, we continue to expect a return to rate hikes in December.
Yellen’s comments on inflation were amusing.
“The shortfall of inflation this year is not largely related to cyclical factors and is more of a mystery,” she said at the presser, adding that she “would not say that the committee clearly understands what the causes are.” Obviously, that calls for this:
Of course it’s probably not so much that the Fed doesn’t “understand” that there are structural factors at play here (e.g. technology and Jeff Bezos). Rather, it’s more likely that the Fed is clinging to the “transitory”/”it’s a mystery” line simply because it gives them some leeway in terms of proceeding apace with normalization at a time when they’re afraid financial asset prices are out of control.
With the balance sheet set to roll off largely as expected, Yellen had this to offer:
My own judgment, based on my experience and the economic research that has tried to estimate the effectiveness of our balance sheet actions starting in 2008 and has also looked at the similar balance sheet actions in other parts of the world including the euro area, is that these policies were successful.
That depends on your definition of “successful.” As noted in these pages on multiple occasions, the mistake here came in underestimating the efficiency of the transmission channel between accommodative policy and asset prices and overestimating the efficiency of the transmission channel between higher asset prices and the real economy. The “wealth effect” theory broke down right where it mattered – it never “trickled down.”
In any event, markets reacted as you’d expect they might. The dollar rose:
Treasurys fell (note that 10Y yields are now some 27bps higher than they were two Fridays ago):
Financials knee-jerked higher when the decision hit:
But do note that the Treasury sell off was led by the belly as the curve flattened.
Stocks fell to their lows of the day but as the press conference wore on, Yellen seemed to soothe equity investors’ nerves and dips were bought:
Same thing in the VIX, which was quickly hammered back to a 9-handle:
Notably, gold did not manage to recover from its Fed knee-jerk:
In some respects, it’s probably fair to say that Yellen managed to thread the proverbial needle on Wednesday. She feigned confusion over subdued inflation, which essentially allows the Fed to substitute the “transitory” excuse for the scary-sounding “we’re concerned about asset bubbles” when explaining why they are largely undeterred when it comes to normalization.
Risk assets took things in stride, which is what you want if you’re a policymaker – at least initially. That is, even if what you are trying to do is take some air out of the bubbles, you don’t want them to start deflating immediately because then people get spooked.
I suppose the question now is whether December still looks like a good idea in December. And that’s not as tautological as it sounds. Because remember, the December meeting will likely coincide with a new round of fiscal wrangling and all the political turmoil and market angst that comes with it.
In the meantime, watch yields – what’s going to be key here is the extent to which the market is able to digest both the commencement of balance sheet rundown and an unchanged rate hike path without throwing a “tantrum.”
Finally, in case you haven’t had enough of “connecting the dots” today, here’s another exercise for you…