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Forex News – Fed holds rates; Avoids signalling March hike but more confident on inflation

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The Federal Reserve’s Open Market Committee (FOMC) kept interest rates unchanged on Wednesday at the first policy meeting of the year and the first since Donald Trump took office as US President. The decision was widely expected given that the Committee had only raised rates in December by 25bps to a target range of 0.50-0.75%.

The language of today’s FOMC statement was largely similar to recent meetings’ but there were a few notable changes, in particular, with regards to inflation. In previous statements, the Fed had stuck to the view that inflation “is expected” to rise to the 2% target over the medium term, but this had changed to “will rise” to 2% in today’s statement. The Fed also removed the reference to inflation picking up once the transitory effects of the drop in energy and import prices have dissipated, indicating that the Committee no longer sees these effects being present. In fact, the Fed acknowledged that inflation had “increased in recent quarters”, suggesting that the Committee appear to be taking the view that inflation in the US is finally on a more sustained path upwards.

On the economy, the Fed added little new to its outlook and maintained its forecast of moderate growth in economic activity and “somewhat further” improvement in the labor market. Although it continued to see business investment as being “soft”.

The dollar came under pressure after the announcement as many analysts were expecting the FOMC statement to be more hawkish. The greenback slid from around 113.50 yen prior to the decision to a session low of 112.82 yen, before rebounding slightly to around 113.00 in North American trading. The euro bounced back to around 1.0770 dollars and the pound firmed slightly to 1.2668 dollars.

While the Fed has clearly kept the door open for a rate hike at the next meeting on March 14-15 with its upbeat assessment of inflation, it has once again avoided committing to such a move by using stronger language. However, FOMC members will have plenty of opportunity in the interim to signal a rate hike should the incoming data until then be positive. The next big data is expected this Friday with the release of the non-farm payrolls report for January.

One possible explanation for the cautiously hawkish tone is the change in the FOMC composition in 2017. The four new incoming voting members, Charles Evans, Patrick Harker, Robert Kaplan and Neel Kashkari, are known to be more dovish than the departing members, Esther George, Loretta Mester, Eric Rosengren and James Bullard.

Another possible factor is there is still a lot of uncertainty about Donald Trump’s economic policies despite much talk of tax cuts and infrastructure spending. Some Committee members had already factored in looser fiscal policy in their quarterly rate projections at the December meeting. However, the median forecast of three rate hikes in 2017 was mostly based on there being no major change in economic policy, meaning that the Fed could move even faster if Trump delivers on his election pledges.

In the meantime though, markets are currently pricing just two rate increases this year. Any change therefore in the Fed’s tone or in fiscal policy could still have the potential to drive up the dollar further if market expectations catch up accordingly.