- FOMC statement: it was consistent with investor and market expectations. With its two criteria having been met (price stability and full employment), the Fed indicated that the start of the rate normalisation cycle is soon. The Fed probably avoided referring to the next meeting scheduled in March to give them optionality should external events have a detrimental impact on growth. The Fed recognised that the recent rise in Covid-19 cases has weighed on short-term growth prospects, but would not be long lasting. The asset purchase programme will end in early March.
- Press conference: Chair Powell surprised investors with his hawkish tone. He did not explicitly rule out future actions such as hiking the policy rate at every meeting this year or increasing the policy rate in increments greater than 25 basis points (bp). The Fed appears uncomfortable with the high level of inflation and its persistence. While the statement did not include a date when the rate hiking cycle would begin, Chair Powell said they will decide in March, but most on the FOMC are looking to hike in March. He stated that the Fed funds rate will be the primary means to tighten policy. Quantitative tightening (QT) will occur only after the start of the rate-hiking cycle. The Fed will allow securities to roll off the balance sheet, presumably swatting back the prospects of the Fed immediately selling assets. The balance sheet principles pulled forward QT expectations and could begin as early as June.
- Market reaction: Financial markets sold-off following the press conference. US Treasury yields rose across the curve, leading to a flattening of the yield curve. Equity markets soldoff modestly, with the S&P 500 index closing at -0.2%. Overnight the Nikkei index sold-off over 3%. Today, European equity markets are selling-off more heavily, except for the German DAX index. The dollar rallied 0.5% notably against low -yielding currencies like the euro, Japanese yen, and Swiss franc.
The hawkish pivot by the Federal Reserve (Fed) in November and December set the scene for taking a big step toward normalising policy and formally acknowledging the need to exit various aspects of its emergency accommodation. Yesterday’s Federal Open Market Committee (FOMC) statement was drafted to prepare markets for policy rate ‘lift-off’ in March and reinforce current market implied policy expectations. The statement delivered on both goals and, as such, there was little initial market reaction. It was not until Chair Jerome Powell’s surprisingly hawkish press conference that US interest rates shifted higher, the yield curve flattened and other financial markets sold-off.