December FOMC: The Fed opens the door to more hikes - TDS

Research Team at TDS notes that the US Fed raised its fed funds rate by 25bps and indicated a more hawkish stance on the near-term policy path.

Key Quotes

“In our view, the upgrade to the pace of policy firming in 2017 (3 hikes vs 2) incorporated prospective fiscal stimulus measures to some extent paired with diminished levels of labor market slack, both of which point to greater scope for overshooting. If anything, the Fed has seemed to open the door to upgrade their policy intentions from here – all the while being data dependent – rather than suggest a Fed that will be dovish at all costs.”

“There were important tweaks in the statement in our view which on balance reinforce a less dovish stance going forward. First, inflation compensation was still seen as running low and not yet to the point of comfort, such that sustained levels above 2% are desired. Second, the statement highlighted that only "some" further strengthening in labor markets is needed, indicating a closer proximity to full employment. So even though the Fed would like to see breakevens higher, they are also opening the door to the market raising fed funds expectations for 2017 from here.”

“Rates Strategy: With Yellen stressing that she never advocated a policy of “letting the economy run hot” and suggesting that fiscal policy makes sense when the unemployment rate is much higher, any fiscal easing will also weigh on the belly of the curve. As for the level of rates, with 10s finally breaking through stubborn support at 2.50%, we believe convexity hedging stands the risk of accelerating any selloff in rates. We continue holding on to our 3m10y payer spread. We do think that rates will stabilize around the 2.75-3% level since the rise in real rates will begin to hurt growth, inflation and financial conditions.

“FX Strategy: The USD stands to benefit widely against the other major currencies now that the Fed has taken a clear hawkish step this month. The uptick in the term structure of the ‘dots’ provides medium-term support, while a notable lack of dovish backtracking during Chair Yellen’s press conference points to further shorter-term gains.”

“EM Strategy: The dot plot revision and Yellen’s overall rhetoric have hawkishly nuanced the message, which is textbook negative for EM FX. However, we would not expect these moves to be long lived. As long as US growth remains solid, and the Fed does not embark in an aggressive tightening cycle, we think EM FX should stabilize soon.”