POST-FOMC: Muted Statement Signals On Course for Dec Hike

By Jean Yung

     WASHINGTON (MNI) - Federal Reserve officials Thursday held fast to their

upbeat assessment of the U.S. economy, leaving markets to anticipate another

quarter-point hike next month and more to come next year. 

     At the close of the November meeting, policymakers left the target range

for the fed funds rate unchanged at 2% to 2.25%, as expected, and made no

significant edits to the policy statement. That suggests that if the economy

continues to perform in line with expectations, it would warrant a fourth

increase in the benchmark rate for the year in December -- something a majority

of policymakers have said is appropriate. 

     Despite trade policy uncertainties and a turbulent month for equities,

risks to the outlook remain "roughly balanced," the Fed said, without mentioning

specifics. Most officials view trade disputes as potentially hurting growth, but

they've also been careful to add that they have yet to see an impact in

investment or hiring data.  

     Policymakers forecast raising short-term rates three more times next year.

As rates inch closer to their estimated neutral setting of around 3%, the

question remains how will Fed officials determine policy going forward. However

there was no hint on the specifics of that discussion in Thursday's policy

statement. 

     --BALANCE SHEET TALK

     With the economy largely on track, sources told MNI ahead of this week's

meeting that the Federal Open Market Committee would pick up the long-running

discussion over its policy implementation framework and the Fed's balance sheet.

     The Fed needs to decide whether to keep its existing "floor" system for

setting interest rates or revert to a pre-financial crisis and reserve-scarce

"corridor" approach. The former would allow the central bank to operate with

hundreds of billions more bank reserves than the latter, and would mean a larger

balance sheet going forward.

     Conversely, a shift in the Fed's operating framework back to a

reserve-scarce system would mean the Fed might have to reduce its balance sheet

more than market participants currently expect. Traders say it could also lead

to greater volatility in short-term interest rates.

     All eyes will be on the release of the minutes of Thursday's meeting on

November 29 for details of those discussions and the FOMC's anticipated timeline

for making key decisions. 

     --IOER TWEAK COMING?

     In recent days the effective fed funds rate has risen to 2.20%, equaling

the interest rate the Fed pays on excess bank reserves for an extended period

for the first time in history. In the current floor system, the Fed achieves its

rate target by setting the IOER, and until June, IOER was set equal to the upper

upper limit of the target range. 

     However, as the fed funds rate rose steadily this year, the FOMC was forced

to set IOER 5 basis points below the upper limit of the range in a bid to ensure

control over its policy rate. 

     Fed officials did not make any "technical" adjustment to IOER Thursday,

though analysts continue to speculate it will do so at next month's meeting,

tweaking the IOER by another 5 to 10 basis points toward the center of the

target range. 

     The FOMC has said a surfeit of Treasury bill issuances this year is the

primary driving force behind the rise in the fed funds rate, but some investors

argue that a growing scarcity of bank reserves is a significant factor. They

will be looking carefully at the meeting minutes for hints on both the next IOER

tweak and what significance it holds for balance sheet normalization. 

--MNI Washington Bureau; +1 202-371-2121; email: jean.yung@marketnews.com

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