Federal Reserve Strategy Intact

The Federal Reserve stuck to its strategy despite recent disappointing data.  It still envisions another rate hike this year and being able to begin reducing its balance sheet later this year.

Throughout the recovery and expansion, the Fed has underestimated how fast the unemployment rate fall.  They have again revised lower where the unemployment rate is headed.  Moreover, the Fed edged its core PCE forecasts lower, and the median fell to 1.7% from 1.9%.  However, in 2018 and 2019, the Fed still thinks its 2.0% target will be reached.   

There was a single dissent from the decision to hike rates.   Kashkari dissented.  It is not very surprising.  He has been particularly dovish due to the easing of price pressures.  

The Fed's statement also provided more details about the balance sheet.  It will allow up to $10 bln a month ($6 bln Treasuries and $4 in MBS) that will not be replaced by maturing issues.   The monthly amount will increase quarterly by $6 bln and $4 bln for Treasuries and MBS respectively.  This will be allowed to gradually increase to $30 and $20 bln It anticipates that it will be the balance sheet operations later this year, with an important caveat, the economy needs to "evolve broadly as anticipated."  This seems a somewhat more aggressive path than many economists had anticipated. 

The dollar firmed in response to the FOMC statement, and yields across the coupon curve rose a couple of basis points, paring the earlier sharp drop recorded in the wake of another series of poor data (weaker retail sales, softer CPI, and a draw down of business inventories.  To be sure, Yellen reiterated that the Fed funds target remains the primary policy tool, but it will use all tools at its disposal should they be necessary.

Yellen's remarks seemed to play down the pullback core PCE deflator.  She seemed to dismiss it as a bit of a statistical fluke involving the price of wireless telephone service and prescription drugs.  She cautioned against over-emphasizing short-term high frequency data.  Again, the deviations from the Fed's expectations are not seen as major or sustainable.  The Fed still see the Fed funds rate target as still below neutral.  The dollar pared more of its earlier losses in response to Yellen's initial remarks. 

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