The dark side of the hike
The Fed’s decision today offered few surprises. They finally stopped vacillating andhiked rates by 25 bp. It was a “dovish hike”: the statement, the forecasts and the press
conference underscored a gradual pace of hikes ahead. However, as we also anticipated,
it wasn’t dovish enough to “dovetail” with rate market expectations of only two hikes
next year. The dot plot continued to show that the Fed expects to hike by 100bp next
year, which is much slower than history but still well above market expectations (Chart
1). At the same time, the statement’s more optimistic tone was welcomed by the equity
market.
It is hard to hike and “hug” the bond market at the same time. The FOMC statement is
directed not only to financial markets but to the American public. The Fed needed to be
clear why—after so many years—it is finally hiking. Moreover, we think the Fed would
not be hiking unless it expects more to come. If Fed’s message is too dovish, it could
raise doubts about why they are hiking in the first place.
In our view, there were three key messages in the statement. First and foremost, the
Committee is confident about achieving both sides of their dual mandate. Specifically,
“the Committee judges that there has been considerable improvement in labor market
conditions this year, and it is reasonably confident that inflation will rise, over the
medium term, to its 2 percent objective.” Second, they recognized “the time it takes for
policy actions to affect future economic outcomes.” This explains why they are hiking
before inflation has actually picked-up. Third, they presented a unified front. Among the
voters, three members had expressed reservations about hiking today, but none of the
three dissented. Presumably few non-voting hawks did not support the move, but even
they conceded some ground by lowering their forecasts for rate hikes next year.
Yellen mind control
The press conference not only gives the Chair a chance to flesh out the statement in
more detail, it gives the press a chance to question the decision. This can create an
interesting dichotomy where the prepared comments lean in one direction while the
answers to questions lean in the other direction. In September, Yellen wasn’t able to
focus attention on the FOMC’s decision as a tactical delay, as many of the questions
were about “why didn’t you go” and “what has changed in terms of your priorities.” In
defending why the Fed didn’t hike, Yellen ended up sounding very dovish. Now that the
Fed finally has hiked, the questions today were variations on “why did you go now”?
Yellen thus ended up sounding somewhat more hawkish than her main message of a
very patient Fed that intends to raise rates gradually and only as the economic outlook
supports further moves.