Fed State of Play: Dec Rate Hike Still Strong Possibility

By Karen Mracek

     WASHINGTON (MNI) - The Federal Open Market Committee's message Wednesday in

its post meeting statement was clear: Don't rule out another 25 basis point rate

hike this year

     The FOMC did exactly what markets expected in its post-meeting statement --

pushing forward the idea that the reinvestment policy change was coming

"relatively soon," regardless of inflation data, and reinforcing that it has

time to see if the weaker-than-expected inflation readings turn out to be

transitory as they expect.

     Yet some read the Fed's statement -- including its acknowledgement that

inflation declined and "running" below its 2% target -- as the FOMC taking a

more dovish stance. 

     This isn't the right way to read this. The tweaks to the inflation language

were backwards looking, an assessment of data already in hand. The FOMC did not

change any language around the forecast in which they still expect inflation "to

stabilize around the Committee's 2 percent objective over the medium term."

     So while markets may have read the removal of "somewhat below" target as

dovish, or a sign the FOMC was wavering on another rate hike, the FOMC is still

on track to raise rates again in December. This is the base case for voting FOMC

members.

     That's not to say a December hike is a done deal, just that the FOMC's bias

is to make another hike this year and take another step towards a neutral policy

stance. And the FOMC is content to wait for more inflation data.

     The most important tell for a December rate hike will be in the Summary of

Economic Projections accompanying the September FOMC meeting. This will signal

whether the weaker inflation is actually shifting their forecasts and when FOMC

members expect core PCE to reach the 2% target.

     In the June SEP, the FOMC's median expectation for core PCE fell to 1.7%

from the 1.9% in March. And still the median expectation for rate hikes was for

one more 25 basis point increase this year. A further dip below 1.7% in the

median forecast would likely be a sign a December hike is off the table.

     But Fed Chair Janet Yellen already warned the inflation data is expected to

be weak through next March. "We had an exceptionally low reading on core PCE in

March," she said in her June press conference, "and that will continue to hold

down 12-month changes until that reading drops out."

     Of course there will be a lot of data and speeches before the September

meeting, including two monthly PCE readings, two more CPI readings and a look at

second quarter GDP. The Fed will have plenty of information by then to determine

if their forecast needs to change and whether another hike this year is still

appropriate.

     While markets will have to wait for more information about rate hikes, one

thing they won't have to question is the timing of quantitative tightening, or

the change in the Fed's reinvestment policy to begin shrinking their $4.5

trillion balance sheet.

     By adding "relatively soon" to the statement instead of "this year" --

repeating what Yellen said in response to an MNI question at her June press

conference -- the FOMC made it clear they are ready to move in September, with

implementation likely to begin Oct. 1.

     While unforeseen circumstances could delay this, the FOMC has made it clear

this decision is not going to be deterred by weaker inflation data. 

     Furthermore, the FOMC is unlikely to move on the balance sheet and make a

rate hike at the same meeting. So a move on reinvestments in September gives the

FOMC time to onboard additional inflation data before making a rate decision in

December.

--MNI Washington Bureau;tel: +1 202 371-2121; email: karen.mracek@marketnews.com

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