Most expected today’s Fed meeting to be a non-event. Despite initial appearances, it didn’t turn out that way.
“At first glance, you would conclude it was just a placeholder meeting because no action was taken,” says Robert Spector, portfolio manager at MFS Investment Management in Toronto. “But the sub-text was that there was actually quite a bit going on.”
He identifies three key points:
1. Global risks
Risk assets such as equities and corporate bonds have been trading better from February lows, notes Spector. “And government bond yields have been rising—not dramatically, but they’re no longer falling.”
But the Fed’s statement today underlined its view that global developments continue to pose risks. “There’s a feeling that the balance of risks isn’t neutral, [isn’t] skewed to the upside. They’re still somewhat skewed to the downside.”
He says one of the things the Fed has been “captive” to over the past several years is that “every time they want to be a little bit more hawkish on the rate environment, it ends up backfiring in that the dollar starts to rally, there are market strains, commodity prices come down, there’s emerging market weakness, and that tightening in financial conditions then gets the Fed to back off. Then all of a sudden things look better again, the data comes in better, financial markets rally, and then the Fed comes back on the table [with a possible rate hike], and you get that loop again where things get weak.”
He notes the Fed wants to raise rates this year, “but they really want to get across the view that this is going to be a very different, very muted rate cycle. And by continuing to cite these global strains, they avoid the market starting to aggressively price in rate hikes, which would then undo this recovery in markets that’s been apparent the last month.”
Recently, some inflation readings have been creeping higher, particularly core inflation. “The Fed didn’t really amp that up in the statement,” notes Spector. “I wouldn’t say Chair Yellen dismissed it, but she didn’t explicitly show any worry about the higher trend in core inflation in her press conference. And in the economic projections, they actually took down their expectations for core inflation versus December, which seems weird because inflation’s been going up.”
In short, it was surprising that Yellen didn’t “elevate [inflation] as a little bit more of a concern.”
Spector notes there was a widespread consensus among Fed watchers that the dot plot—the median projection for the federal funds rate for 2016—would show a decline from four rate hikes to three for the year. But it fell to two hikes.
“So you have three things going on that were a dovish surprise in what people thought was going to be a placeholder meeting,” concludes Spector.