The market response in the wake of the Federal Open Market Committee’s July meeting statement was dovish, perhaps because there were corners of the market still hedging or expecting the start to the balance sheet normalization as soon as at today’s meeting.
*** In any case, the FOMC statement was wholly in line with our expectations, pointing to September for the start to balance sheet normalization that will come “relatively soon” (SGH 7/21/17, “Fed: A July Preview”). We expect a well-coordinated messaging campaign in the coming weeks to prepare the markets and public alike for the formal announcement at the September meeting, with the modest initial phase of the balance sheet run-off likely to begin with one of the Treasury debt auctions at the end of October or perhaps November. ***
*** The Committee also shied away from any new signal on rates, more or less keeping its language changes to a minimum. In the statement’s descriptive first paragraph, the FOMC wordsmiths acknowledged current inflation was below rather than merely “somewhat” below 2%. But just in case too much was made of the tweak, they affirmed in the more forward-looking second paragraph that inflation “on a 12 month basis” is still expected to be “somewhat below” 2% before it, in effect, rises to “stabilize around” the 2 percent objective. ***
In other words, we suspect that is shorthand for a Committee majority still betting on a continued gradual pace of rates policy normalization with one more rate hike this year, probably in December, assuming of course the data stays on track with the forecast.
Until then, the FOMC will be monitoring the inflation data — paying particular attention to the surveys and measures of inflation expectations (see SGH 6/25/17, “Fed: Inflation and the Near Outlook”) — and probably punting a decision on whether “something else is going on” in the inflation dynamics to at least the October 31-November 1 FOMC meeting.
One last point, while the FOMC has already indicated what it will do in the capped run-off of some maturing assets once the balance sheet normalization begins, they have still to say what they will do with the rest of the maturing assets that will be reinvested, for instance, whether they will be rolled over into the maturities of the Treasury’s debt issuance at the respective auctions or perhaps shortened a bit. The answer to that is likely to be the most pertinent takeaway in the July meeting Minutes on August 16, if not in the hints here and there in upcoming speeches.