Yellen Speaks Softly, Market Overreacts

The FOMC statement was little changed from July.  It reiterated that there was “significant” slack in the labor market, despite continued improvement.  It repeated that rates would likely remain low for a “considerable” time after the end of QE.  It also  again indicated that even after the Fed’s employment and price objectives were neared, Fed funds would likely remains below the “normal” long-run level.  The Fed’s economic assessment saw minor tweaks recognizing the ongoing improvement of the economy. 

This is largely in line with our expectations and more dovish than the market expected.  However, the quick knee jerk reaction read the statement hawkishly.  First there were two dissents:  Plosser and Fisher.  The objections were over the forward guidance.  They did not advocate an immediate rate hike (as the two dissents from the Bank of England).

Second, the Fed’s dot plot saw a small increase in the Fed funds at the end of next year from 1.125% to 1.375%.    However, as Yellen has cautioned before, the dot-plot is not policy.  Nevertheless, US interest rates rose across the curve and the dollar rallied across the board.   The market seemed to avoid sterling, which was little changed, and expressed its bearishness through the selling the euro, yen and Australian dollar.  Equities rallied.

We suspect the market read into the statement and projections a greater hawkishness than the majority of Fed intended.  The big picture view has not changed.  The Federal Reserve will hike rates around the middle of next year.  The Fed will likely raises rates 2-3 times in 2015.  We had been thinking Fed funds would finish 2015 near 1.0%.  We are reluctant to alter this view based on today’s statement.