Interest Rates Moving Higher Despite Dovish FOMC Statement – Here’s the Need To Know

The FOMC meeting and statement generally met expectations, although on balance the statement was taken as slightly dovish (which shouldn’t surprise anyone).  There were four wording changes in the statement from June:

First, “Information received since the Federal Open Market Committee met in May suggests that economic activity has been expanding at a moderate pace” was changed to “Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year.”

This represents a bit of a economic downgrade, likely reflecting the low GDP numbers for both Q1 and Q2 that were released yesterday morning.

Second, “and the housing sector has strengthened further, but fiscal policy is restraining economic growth” was changed to “the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth.” 

This language change obviously points out the Fed is not oblivious to the uptick in mortgage rates, and shows the Fed understands just how important a continued housing recovery is for the economy.

Third, “The Committee also anticipates that inflation over the medium term likely will run at or below its 2 percent objective” was changed to “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.” This was no doubt added at the urging of Fed President Bullard, who dissented in the June meeting because the committee didn’t explicitly acknowledge the risks of currently low inflation.  Apparently his arguments carried more weight this month, which means that at least some on the Fed are getting a bit worried about stubbornly low inflation.

Finally, the committee “reaffirmed” that monetary policy will remain highly accommodative until long after QE ends. (“Reaffirmed” was likely added to pave the way for extension of the forward guidance at the September meeting when tapering will likely begin.)

Bottom Line

The statement was taken as dovish, but the Fed has been trying to “talk down” rates for nearly a month now, so I don’t know why this was so surprising.  With regard to WWFD (What Will the Fed Do) the bottom line remains it’s not a question of “if” the Fed will taper; it’s a question of “when” (September or December).  Either way, tapering is going to occur this year, and the marginal direction of policy for the Fed is toward less accommodation, which is ultimately dollar-bullish/bond-bearish. The Friday jobs report (and data this morning) just got even more important, too—if the jobs number is particularly weak or strong, look for violent reactions in bonds and currencies.