FOMC Holds Fed Funds Steady in 0% to 0.25% Target Range; Reduces Monthly Asset Purchases by a Further $10 Billion

The Federal Open Market Committee (FOMC) met expectations and cut a further $10 billion from the pace of monthly asset purchases. Beginning in October, the Fed will purchase $5 billion of agency mortgage-backed securities (MBS) and $10 billion of longer-term Treasuries per month, down from $10 billion and $15 billion, respectively. The statement included an explicit statement that if the data show the economy is progressing in line with the Fed's mandate with respect to the labour market and inflation, the asset purchase program will end at the October meeting.

No change was made to the fed funds target range of 0% to 0.25%. Perhaps in light of the unexpected decline in the headline and core CPI rates reported this morning, the FOMC tweaked its characterization of the current state of inflation saying the rate "has been running below the Committee's longer-term objective", rather than describing it as having "moved somewhat closer to the Committee's longer-term objective" as in July. That said, the statement maintained  that the downside risks to the inflation outlook have  "diminished somewhat" although qualifying that this is "since early in the year".

The Fed also maintained its forward guidance that the fed funds rate will likely be held in its current range “for a considerable time after the asset purchase program ends.” Two members voted against today's action. Charles Plosser and Richard Fisher objected with Fisher pointing to stronger economic conditions as likely to warrant an earlier reduction in policy support and Plosser reiterating that he deemed the statement to be "time dependent" and not taking into account the "considerable economic progress" that has been made toward the Fed meeting its goals.

The statement noted again that economic conditions may warrant keeping the fed funds target “below levels the Committee views as normal in the long run,” even after the employment and inflation have reached “mandate-consistent levels.”

The FOMC also provided information about how the committee envisions the process of policy normalization to play out. These plans include using the Fed funds target as the key policy tool with the Fed to "commence phasing out reinvestments" after the initial hike. The Committee does not anticipate selling its holdings of agency mortgage-backed securities. The goal is for the Fed's balance sheet to be only as large as needed to conduct monetary policy "efficiently and effectively".

The statement noted that the economy was growing at a moderate pace pointing to increases in consumer spending and business investment with growth in the housing sector “slow.”  The statement acknowledged that labour market conditions "improved somewhat" while pointing to the relatively steady unemployment rate and a wider range of labour market indicators as showing that "there remains significant underutilization of labour resources."

Also released was the FOMC's updated economic forecast. The range for 2014 GDP growth (on a Q4/Q4 basis) inched down to 2.0% to 2.2% from 2.1% to 2.3% in June. After incorporating the unexpectedly sharp rebound in activity in the second quarter following the weather-related drop in output in Q1, the annual 2014 range implies growth in the second half of the year averaging about 3%. The expected growth range for 2015 was also lowered to 2.6% to 3.0% from 3.0% to 3.2% in July. The projection for 2016 was changed to 2.6% to 2.9% from 2.5% to 3.0% with the addition of 2017's forecast range of 2.3% to 2.5%. The expected range for the unemployment rate in the final quarter of 2014 was lowered slightly to 5.9% to 6.0% from 6.0% to 6.1% with the 2015 end-of-year range at 5.4% to 5.6% (vs 5.7%). The expected range at the end of 2016 was 5.1% to 5.4% (vs 5.5%) with 2017 range at 4.9% to 5.3%. The “longer-run” range of 5.2% to 5.5% was unchanged.  Inflation forecasts were little changed.  The projected range for headline PCE inflation in 2014 is 1.5% to 1.7%, with 2015 at 1.6% to 1.9% while the 2016 range 1.7% to 2.0%.  Core inflation in 2014 held at 1.5% to 1.6% with 2015 at 1.6% to 1.9% (vs 2.0%) and 2016 at 1.8% to 2.0% (was 1.7% to 2.0%). In 2017, both the all-items and core PCE deflators are forecast to be in a range between 1.9% to 2.0%.

The “dot plot”, which provides a summary of participants’ expectations for the fed funds rate at the end of each year, revealed modest shifts. There remains only one participant who thinks the rate should be increased this year. At the end of 2015, 11 participants expect the rate to be higher than 1.0% with six expecting the rate to be below 1.0% at the end of next year. In 2016, seven expect the rate be less than 3.0% with seven expecting the rate to be between 3% and 4.0%. Three members look for the funds rate to be less than 2% by the end of 2016. The median forecast for 2016 is 2.9%. 2017's projections were added and showed 14 members expect the funds target to be slightly above 3% to a high of just below 4.5% and the median rate at 3.75%. Likely this is the range FOMC members consider to represent a neutral policy rate stance based on the assumption that policy rate increases will start in 2015.

The tweaks to the forecasts were small with growth projections trimmed back although this did not translate into expectations that the unemployment rate will remain higher for longer. The updated blueprint for the exit strategy confirmed that the fed funds target will remain the Fed's primary policy tool and the Committee expects to wait until rate increases are underway before the Fed will turn to the process of reducing the size of its balance sheet. The Chair reiterated numerous time that this policy outlook was conditional with stronger growth and inflation and lower unemployment opening the door to a quicker tightening in policy while a slower improvement could result in policy stimulus being maintained for longer. Today's statement does not change our view that, with the US economy likely to continue to grow at an above-potential pace, the Fed will be in position to start the process toward policy normalization in the middle of next year with the first hike in the fed funds target likely to be announced in June 2015.

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.

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