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Dovish FOMC ‘promises’ zero rates for three more years!

Dovish FOMC ‘promises’ zero rates for three more years!

26.1.2012 9:28

Fed remains very cautious on growth and sees downside risks to inflation. It for the first time defines its inflation objective, but most important suggests that rates will not be raised until at least through late 2014. Also Bernanke’s comments were very dovish, keeping the door wide open on more QE.

  • Fed remains very cautious on economic outlook....
  • Sees downside risks to inflation.....
  • Downside financial risks significant
  • Defines price stability objective as a 2% annual change in PCE deflator
  • Inflation and maximal employment objective have equal weight
  • Fed still pondering additional QE-3 accommodation
  • Continues operation twist and re-investment maturing assets
  • But most importantly anticipates very low rates at least through late 2014
  • Modest Market reaction suggest dovish outcome largely anticipated

In a historical meeting, the FOMC took a number of far-reaching changing to the
way it will model and communicate its policy. It specified for the first time ever its
price stability objective as a 2% annual rate of change in the price index for personal consumption expenditure. It also confirmed the equal weight of its inflation and maximal employment objective. Also for the first time ever, the Fed published the interest rates projections of individual governors for the first interest rate increase and their estimate of rates for the Q4 of the next years.

Besides these institutional changes, which will only be fully understood in the following years, the FOMC delivered also a very dovish message on near term monetary policy prospects. Firstly, the Fed remains very cautious on the economic outlook and qualifies the downside financial risks to the economic outlook as significant, while remaining cautious in describing the recent economic improvement. Secondly, a subtle change in the inflation part of the statement suggests that downside risks on inflation might become a theme.

Thirdly, the FOMC anticipates very low rates through late 2014. That is 1.5 years beyond mid 2013, the previous conditional promise of the Fed. This actually is an important easing of policy.

Fourthly, the interest rate projections show that besides the 5 governors that see a first rate hike in 2014, 4 see a first rate hike only in 2015 and 2 in 2016. Admittedly, 3 governors see a rate hike in 2012 and 3 in 2013. However, it is very likely that those estimates are coming from regional governors that have not always a vote at the FOMC deliberations.

Finally and most importantly, chairman Bernanke, whose views matter most, sounded very dovish in his comments and suggested that the question of more accommodation is on the table.

Market reactions

US Treasuries jumped on the decisions, but the longer end was later on hit by profit taking. Not surprisingly, the belly of the curve outperformed with the 5-year doing better than 3- and 7-year and the 7 doing better than the 10-year. The 30-year was little changed at the end of the day. The dollar was sold, equities gained and so did gold and commodities.

Read more in full report here.

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