The Fed paints a clearer picture of tightening, the dollar rebounds

Gladys Abbott
September 22, 2017

HURRICANE IMPACT: The National Association of Realtors said that sales of previously occupied US homes fell 1.7 percent in August.

US Dollar Index at hourly intervals. Previously, market expects the Fed might raise interest rate again in December.

At a news conference, Chair Janet Yellen said the Fed's two rate hikes this year and its decision to begin reducing its bond holdings were signs of a solid economy and job market. The resolution of the stand-off over the U.S. debt ceiling in Congress has removed the final obstacle to the decision, which the Fed said would proceed at a fixed monthly level that can be adjusted as needed to be either faster or slower.

The U.S. 2-year Treasury yield climbed steadily after the announcement and hit a high of of 1.451 percent, its highest level since November 5, 2008, according to Reuters Tradeweb.

Commenting on the Federal Open Market Committee's decision (and on the more dovish side of things), Philip Marey at Rabobank told clients:"While the Fed remains on course, we still have our doubts about the third rate hike".

Above: The dot-plot graph. This has implications for longer term US Treasury yields, beyond a cyclical tightening. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Fed officials cautioned that they do expect inflation to be higher than normal - at least for a little while - following the hurricanes that have devastated Texas, Florida and now Puerto Rico.

However, the Fed lowered its rate forecast for 2019 to 2.7% from 2.9%.

In addition to the Fed's gradual unwinding of its $4.5 trillion balance sheet, at a pace that will double to $20 billion a month after three months, the European Central Bank is expected to begin tapering its bond buys in coming months.

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All the easy money sloshing around on financial markets burnished bullion's reputation as a hedge against inflation and as a storer of wealth amid the debasement of paper currencies sending gold to an all-time nominal high above $1,900 an ounce by August 2011.

The FOMC's decision marks the beginning of a great unwinding of the Federal Reserve balance sheet, which swelled from around $800 billion before the financial crisis of 2008, to almost $5 trillion today - thanks largely to quantitative easing.

Current Fed policy requires the central bank to reinvest the proceeds from maturing bonds.

In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee's Policy Normalization Principles and Plans.

YDSTIE: The Fed is very gradually paring back its balance sheet to avoid spooking the financial markets.

The S&P 500 bank index gained more than 0.7 percent to its highest since early March, led by gains of more than 1 percent in a clutch of large regional lenders, including Suntrust Banks Inc, Zions Bancorp, PNC Financial Services, M&T Bank Corp and Regions Financial Corp. It will be interesting to see what the market reaction once the plan is formally put into place.

While the central bank left rates unchanged, it cited low unemployment, growth in business investment and an economic expansion that has been moderate but durable this year to build its case for another rate hike in 2017.

Credit Agricole maintain the view that the United States dollars would need to see either major fiscal stimulus or a broad acceleration in inflation to post a sustained rally. The FOMC also has a two-day meeting slated for October 31 and November 1.

The Fed has telegraphed its move for months, and investors are thought to be prepared for it. We still think EUR-USD corrections will remain contained and the area around 1.1850 should prove to be a strong support zone.

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