The Market Today

FOMC to Begin Balance Sheet Adjustment in October; Lowers Longer-Run Fed Funds Projection; Surprises with Commitment to Near-Term Hikes

by Craig Dismuke, Dudley Carter

FOMC to Begin Balance Sheet Adjustment in October; Lowers Longer-Run Fed Funds Projection; Surprises with Commitment to Near-Term Hikes: The FOMC left its target Fed Funds rate range unchanged at 1.00-1.25% and voted to begin normalizing its balance sheet in October.  They will begin by letting up to $10 billion per month roll-off from their monthly cashflows – to be adjusted every three months.  In their Official Statement, the Committee made only minor changes to its language assessing economic activity and monetary policy.  They acknowledged better business investment, highlighted that the recent Hurricanes are expected to cause only temporary disruptions in economic activity, and held to their belief that inflation would return to their target 2% over the medium term.


The surprises from yesterday’s announcement came in the forward rate projections.  While the economic projections were largely as-expected, the rate projections showed an unwavering commitment to hiking again in 2017 and a median forecast still calling for three hikes in 2018.  Investors expected to see a few more participants electing no more hikes in 2017 but that number held at just four.  As for 2018, while the median year-end projection held at 2.125% (implying three hikes), the average YE18 projection did drop from 2.23% to 2.04%.  There is momentum moving toward the market position of a lower future path for the Fed target rate range.  Nonetheless, the perceived commitment to another hike in 2017 and three more in 2018 gave the markets a hawkish surprise.


Conversely, the FOMC’s median longer-run rate projection did drop from a 3.00% neutral rate to 2.75%.  This projection for where the overnight rate will eventually settle has now declined from 4.25% back in 2012 to 2.75% today.  This reflects the FOMC’s belief that this rate cycle will be much more shallow than previous rate cycles.  The further this neutral rate comes down, the larger the market implications become for the future shape of the yield curve, asset valuations, etc…  Nonetheless, investors yesterday were focused on the surprising hawkishness in the near term.


Today’s Calendar – The Market Digests FOMC Decisions: Today’s calendar will bring a handful of economic reports but the real focus for investors will be the fallout from yesterday’s FOMC decision.  The 10-year Treasury yield has pulled back a few basis points coming into this morning, down to 2.26% in early trading after closing in on 2.29% yesterday afternoon.  The 2-year Treasury yield, adjusting to the FOMC’s commitment to another 2017 hike, is holding fairly firm at 1.42%.  The Dollar has held onto its post-FOMC gains, up 0.8% from just before the announcement.  Stock futures are, however, down a few points after rallying yesterday afternoon to hit new record highs (more below).  The volatility today is more likely to come from longer yields and equity markets as traders attempt to make sense of some subtle shifts from policymakers.


Initial jobless claims for the week ending September 16 pulled back significantly, dropping from 282k to 259k, as the hurricane effect begins to wane.  The Philadelphia Fed’s Business Outlook index beat expectations, rising from 18.9 to 23.8 (exp. 17.1).  At 8:00 a.m. CT, the FHFA will release its home price index with home prices weighing on sentiment within the sector, and possibly actual activity.  And the Fed’s 2Q Flow of Funds Report detailing household net worth is scheduled to be released at 11:00 a.m.  There are no Fedspeakers on the calendar today to give their take on yesterday’s decision, but there will be several on tomorrow’s.


Yesterday’s Trading Activity – Fewer Fed Purchases? No Big Deal: Markets remained quiet in front of the Fed’s afternoon announcement but responded quickly once the headlines hit the wires. The Fed Statement saw minor (positive, on balance) changes but it was the Fed’s dot plot that likely spurred the reaction (more below). With the Fed still committed to another hike this year and three more in 2018, yields in the belly of the curve saw the biggest response. The 3-year Treasury yield rose the most, adding 4.3 bps to 1.59%. The 2-year climbed 3.7 bps to 1.44%, its highest yield since October 2008. The 5-year yield climbed 4.0 bps to 1.87%. Longer yields were less affected after the Fed took a hike away in 2019 and lowered its terminal rate expectations. The 10-year yield increased 2.3 bps to 2.27% while the 10-year yield fell 0.9 bps to 2.81%. Fed funds futures also adjusted higher (rates), helping to tighten somewhat the recent divide between Fed and market expectations; to be sure, a notable gap remains. The Dollar also leapt on the unchanged near-term dots. The currency climbed 0.75%. Stocks initially sold-off but recovered during Fed Chair Yellen’s confident press conference appearance. The Dow and S&P finished near session highs and both reached another record close. Oil prices rallied in the background Friday which pushed the energy sector atop the S&P. Financials rose in response to the higher yields. The markets fears of turbulence around the announcement of the official start date and are likely to now focus on any flow effect that may appear starting in October.


Hurricane Harvey Weighs, Adds to Affordability Concerns as Existing Home Sales Slip in August: Existing home sales dropped unexpectedly in August to the weakest pace in a year. The 1.7% monthly decline took the annualized sales pace down to 5.35MM units. The NAR indicated that without the 25% YoY slowdown in sales in Houston, sales would have been closer to unchanged. Houston led the 5.7% drop in sales in the South and a 4.8% decline in the West helped offset a 2.5% increase in the Midwest and a 10.8% surge in the Northeast. While the disruption from Harvey impacted the results, the concerns over affordability remain in play. The median sales price did ease for a second month but was still up by 5.6% YoY. At the same time, a 6.5% YoY decline in inventories marked the 27th consecutive decline over the pace 12 months prior. The number of months’ sales in inventory was unchanged at 4.2 and remains well below the 6 months the NAR considers balanced.

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