As widely expected, the Federal Reserve kept interest rates unchanged, and the overall statement accompanying its November meeting was broadly in-line with the one released in September. The main forward-looking part of the statement was unchanged, with the Federal Open Market Committee (FOMC) reiterating that “The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
One key difference between the two statements relates to an assessment of the impact of hurricanes on growth, the labour market and inflation. The FOMC recognised that “economic activity has been rising at a solid rate despite hurricane-related disruptions.” And regarding inflation, the Fed noted that while the hurricanes put upward pressure on headline inflation via higher gasoline prices, “inflation for items other than food and energy remained soft,” and “both inflation measures [headline and core] have declined this year and are running below 2 percent.” Overall, the FOMC acknowledged that risks to the economic outlook are balanced.
The market reaction to the FOMC statement has been neutral, as evidenced by the little change in yields or the US Dollar following the announcement. The market is still positioned for an interest rate increase in December, and nothing in the FOMC statement suggests otherwise.
While we also expect the Fed to increase its policy rate in December, the market is currently too complacent regarding the number of rate rises next year, in our view. And while we recognise that the pace of policy stimulus withdrawal next year may depend on the new leadership of the Federal Reserve, we also believe that whoever becomes the next Fed Chair is unlikely to make dramatic policy changes in the short term. In our view, the Fed is likely to raise rates at least twice next year and this could take some bond investors by surprise given only one and a half hikes are currently priced in. Complacency in bond investing may prove risky and investors should keep a keen eye on monetary policy developments, in our view.
