US Fed holds to its optimistic outlook even as data sags. Indications are for four more hikes in this cycle and at least one more this year

By Jason Wong

Some much information, so little space and time.  The combination of very weak US CPI data and the FOMC Statement with accompanying press conference has seen a big swing in UST yields and the USD.

It was meant to be a quiet session ahead of the FOMC this morning, but some weak US data threw a spanner in the works.  US CPI inflation and retail sales undershot expectations.  The latter can be explained by some prior upward revisions, but the soft inflation reading was the third weak monthly reading in a row, taking the annual increase to 1.7% y/y, a two-year low.

The soft inflation figure set the scene for a strong rally in US treasuries, taking the 10-year rate down about 10bps to a fresh low for the year of 2.11% and the USD came under pressure.

The Fed announcement itself and economic and rate projections seemed to be closely aligned to market expectations.  The well-anticipated 25 bp hike was delivered and the dot plot of rate projections showed little change to the median, suggesting one more hike this year, and three more in 2018 and in 2019.  These projections remain well below market expectations, which see less than 1½ hikes priced in before the end of next year.

The key line in the statement was the committee “monitoring inflation developments closely”, a nod to recent soft inflation data and that outturns going forward would play a crucial role in the path of policy ahead.  On reducing the size of the balance sheet, the Fed said that balance-sheet roll-off caps would start at $10b/month ($6b of Treasuries and $4b of MBS) sometime this year, rising towards $30b and $20b respectively after a year.  No end-target balance sheet size was provided at this stage.

After the Statement, UST yields nudged up, while the USD lifted off the post-CPI lows.  Fed Chair Yellen gave some fuel for the market reversal as she noted that (low) inflation reflected some one-off price reductions and the FOMC expected inflation to head higher.  After such soft inflation data, the market was looking for Yellen to capitulate on the medium-term outlook for inflation and rates but she hasn’t so far. As I write, the 10-year rate has lifted to 2.14%, still down some 6 bps from the NZ close.  The USD majors index was down as much as 0.7% at one stage but is now flat for the day.

Jason Wong is on the BNZ Research team. All its research is available here.