21 Mar 2019
Fed funds target range held at 2.25%-2.5%
Last night the FOMC announced that the stance of monetary policy remains unchanged, as widely expected. Accordingly the Fed funds target range has been held at 2.25%-2.5%. For now the runoff in the balance sheet remains capped at $50bn per month, but this will change soon (see below)
Yesterday’s decision was unanimous. Its accompanying statement was more dovish than on 30 January. The committee characterised the labour market as remaining strong rather than continuing to strengthen. It acknowledged that the pace of activity had slowed compared with Q4 and that consumer spending and business investment had decelerated. Once again the committee made it clear that it would be ‘patient’ as it mulls what further action on rates it might have to take.
Dot plot shift
Markets pay close (arguably excessive) attention to the ‘dot plot’. The median dot plot now shows no hikes this year, one next and none in 2021. This compares with two increases, one and zero, respectively in December. This adjustment was not a surprise. As alluded to above, a material change concerns a clarification of the Fed’s plans on its balance sheet, in short the reversal of QE. The committee announced that, from May, the cap on the reduction in its Treasury holdings will be lowered to $15bn per month from $30bn currently. Meanwhile its holdings of agency and MBS will be allowed to run down at the current pace of $20bn. In September, the Fed will cease the reduction in its aggregate securities holdings, while from October, maturing agency bonds and MBS will be rolled into Treasuries (up to a limit of $20bn per month). In aggregate, the maximum balance sheet run-off will lowered to $35bn in from May (from $50bn currently) and then halt in October, when the composition of the Fed’s balance sheet will lean more towards Treasuries.
During his press conference, Chair Powell stated that he considered the Fed funds rate to be in a broadly neutral range and on several occasions emphasised the ‘patient’ message, namely that there is no rush for a new judgement on rates. He also explained that the Fed was seeking an overall balance sheet that was about 17% of GDP, or a bit above $3.5trn. He also stated that it would clarify its desired maturity composition of its Treasury portfolio at some stage. Given the more dovish message, the USD fell back against other major currencies to close to $1.1450 against the EUR and $1.3250 versus the GBP. The S&P500 rallied to reverse its early losses. Bonds surged, helped too by an earlier than expected end to the balance sheet run-off. Short-term interest rate markets also rallied strongly. At the time of writing the Fed funds futures strip was pricing in a 45% chance of a cut in the funds target by end-year. This compares with the dot plot view of no change and our in house view of one hike during the autumn.
Yesterday saw the Prime Minister Theresa May formerly request a short Article 50 extension to 30 June via a letter to President Donald Tusk. The EU response was that it was open to a short technical extension, but this would be conditional on PM May being able to pass her deal through the House of Commons next week and would only be until the 23 May (i.e. the start of European Parliament elections). In terms of the calendar for next week the Government will lay out the motion on Monday, with the third “meaningful vote” (MV3) rumoured to be either Tuesday or Wednesday, but we await confirmation. The arithmetic for passing Theresa May’s Brexit plan remains daunting, MV2 saw the government’s Brexit plan defeated by 149 votes and whilst we suspect that some eurosceptic MPs and the DUP will eventually support the deal, there remains an element of the Tory Party which is unlikely to support PM May’s deal no matter what.
The PM herself delivered a speech last night appealing to the public and attempting to put pressure on MPs to support her deal, but if anything the reaction from MPs has been one of anger. One big question is what happens if MV3 fails to pass next week. In this case it is possible that the EU offers a long extension to avoid a ‘no deal’ on the 29 March via an emergency summit at the end of next week, but any long extension is likely to be met with strong conditionality, with the phrase ‘new political process’ mentioned in various places. We may learn more about the EU’s extension options at its summit latter on today, but the noises coming from some EU capitals have not been particularly positive, with Belgium, France and Spain all voicing their concerns overnight.
09.30 UK Retail Sales
12.30 UK BoE Interest Rate Decision
12.30 US Philadelphia Fed Manufacturing