The initial reaction to the Fed was big. But, as Bloomberg's Mark Cudmore notes, there’s much more to come still as the message was about as dovish as could have been envisioned, given it was accompanying a rate rise. Cudmore had argued that long-end yields would fall after the Fed hike, and while an 11 basis-point drop in 10-year Treasury yields on Wednesday might seem significant, he notes it’s not in the context of what happened at the meeting.
Apart from lower commodity prices, solid but not exceptional economic growth, and a lack of runaway inflation, much of my anticipation of a dovish market reaction was based on the fact that the market was very much positioned the other way.
But Yellen didn’t just disappoint the extremely hawkish hopes — she genuinely wasn’t hawkish at all. Of course, she couldn’t be outright negative on the economy and inflation given the Fed was tightening policy — but she went as far as she could in that direction.
Notably, near-term risks to the economic outlook still “appear roughly balanced,” rather than skewed to the upside as some had anticipated. The Fed emphasized it’s targeting a “sustained” return to 2 percent inflation, rather than just reaching that target.
Yellen also reiterated that the benchmark rate will persist for some time below levels that are expected to prevail in the longer run, with “gradual” hikes still the plan.
Not only did the median dot plot not rise above 3 hikes in 2017, but the average barely rose. Only five dots showed more than three hikes this year — the exact same as there were in December. Four hikes weren’t even a near miss — it wasn’t even on the radar of the majority.
And there was no discussion of the central bank balance sheet either. That was only a tail risk but it’s yet another point lacking for the hawks.
Everything about this meeting that could surprise dovishly, managed to do so.
U.S. yields and the dollar have much further to fall as a result.
And given the extreme positioning, we suspect Cudmore may be right…