U.S. dollar strengthens after Fed moves

Posted September 23, 2017

Shares of U.S. banks shot to a six-month high on Wednesday afternoon, lifted by a sharp rise in bond yields after the U.S. Federal Reserve signaled it was likely to raise interest rates again by the end of the year. With hurricanes Harvey and Irma clouding some economic data - temporarily raising gas prices, likely restraining hiring and potentially depressing growth in the July-September quarter - some analysts assumed the bank wouldn't have enough information by December to assess whether the economy had rebounded from the storms.

The Fed described the United States economy as healthy, with moderate growth, solid job gains, momentum in business fixed investment and low inflation. That neutral rate dropped to 2.9 percent in the new forecast, down from 3 percent in the Fed's June forecast.

Fed fund rate futures FFF8 are pricing in about 65 percent chance of a rate hike by December, the highest level since March, and around 50 percent before the Fed meeting. FOMC chair Janet Yellen will then address reporters at a press conference at 7:30pm.

The committee notes that inflation rates will continue to be monitored closely, but they will not be increasing interest rates as of this time.

The unchanged rate-hike outlook was somewhat unexpected as investor expectations of a December rate hike in the run up to the Fed's statement were slim amid expectations the sluggish pace of inflation would force the Fed to abandon its plan to hike rates at least once more this year.

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Bond prices move in the opposite direction of yields.

"Though one member noted that easier financial conditions might warrant tighter monetary policy (the conventional wisdom), another floated the more avant-garde view that elevated risky asset prices were a response to markets adjusting to structurally lower neutral interest rates - a factor which the Fed can not control", said Patel.

"The market doesn't expect anything earth-shattering from the meeting but there are risks on both sides", Greg McKenna, chief market strategist at AxiTrader, said in a commentary. In fact, Yellen acknowledged that the Fed didn't fully understand the reasons for low inflation.

Months of telegraphing by the central bank allowed for the muted market response seen on Wednesday.

A sequence of unexpected natural disasters, inconsequential inflation and deep-rooted personnel changes at the Fed itself are the main factors favouring a more cautious assessment.

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The portfolio includes Treasury and mortgage-backed securities that were acquired during and after the 2007-09 financial crisis in a successful program to prop up the economy. This includes a job market still healing from the Great Recession, lower energy prices and a strong dollar that reduced the costs of imports. However, it will take years for the Fed to reach the level it sees as appropriate for the size of its balance sheet.

Its cautious confidence reflected steady economic growth in the face of bouts of overseas weakness, and a US unemployment rate whose drop has been almost uninterrupted over the last seven years to 4.4 percent last month.

"Clearly the Fed still believes that lower unemployment will eventually translate into a pick-up in inflation".

In some ways, it comes back to the long-term rate projection.

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