"Patient" Fed Cuts IOER, Leaves Fed Funds Flat, Ignores Soaring Asset Prices

With employment and economic growth data shining even as inflation disappoints, and the gap between the market and The Fed remaining vast in terms of next actions, today's FOMC statement (and press conference) is expected to be as 'patient' as possible with Powell desperately sticking to his script.

The market is pricing in 32bps of rate cuts for 2019 and more for 2020...

Since the last FOMC meeting (March 20th) confirmed The Fed's dovish tilt, stocks have soared, gold has dropped, and the dollar and bonds have gained modestly...

At the same time, the yield curve has flattened notably...

And today is expected to confirm no change whatsoever, and no new economic projections, the main event will likely be Powell's press conference.

Here are Bloomberg's Key Takeaways from the FOMC decision:

  • For third straight meeting, the Fed leaves federal funds target range unchanged at 2.25 percent to 2.5 percent, as forecast; it repeats language pledging to be "patient'' on rate changes amid global economic and financial developments, muted inflation pressures.

  • The FOMC adjusts its language on the economy, characterizing economic growth and job gains as "solid'' while saying consumer spending, business investment slowed in the first quarter; the Fed acknowledges both overall and core inflation have declined and are running below 2 percent.

  • The statement shows central bank still reluctant to signal a policy bias in either direction, despite Trump's call for an interest-rate cut -- something projected by financial markets.

  • The decision is unanimous at 10-0; there have been no FOMC dissents since Powell became chairman in February 2018.

No comment whatsoever on markets or valuations amid this asymmetrical dovish bias.

Most notably with Fed funds are trading above interest on excess reserves, The Fed cut IOER by 5bps to 2.35% hoping to push banks to lend rather than parking cash at the central bank.

This is the third time in a year that the Fed has adjusted the gap between IOER and fed funds; the Fed cites a desire to foster trading in federal funds "well within the FOMC's target range.''

To be clear, the IOER is a direct response to the relatively increasing scarcity of reserves (liquidity shortage) amid the balance sheet runoff.

As BMO explains:

The most important development from the FOMC this afternoon was the cut of IOER to 2.35%; a drop of 5 bp while the Committee maintained the target Fed funds range of 2.25-2.50%.

The front-end of the curve is intuitively outperforming on this 'fine-tuning' cut and the curve, which has been grinding flatter on the day, has snapped back steeper. This also has created an outside-day steeper for the curve (very rare), which projects to at least 28 bp in 2s/10s.

Very little was changed in the statement, other than to 'downgrade' the current state of inflation to "On a 12-month basis, overall inflation and inflation for items other than food and energy have declined and are running below 2 percent." The emphasis on lowflation puts the onus on core CPI/PCE to drive the next move for the Fed -- hike or cut. We'll be listening to hear more from Powell at the press conference on this topic.

Bespoke Investment Group macro strategist George Pearkes weighs in:

Focus will be on the change in tone around inflation language and "slowed" first quarter numbers but to me that seems to be a justification for the "patience" rather than a forecast given multiple FOMC members have commented on upside data surprise ahead of the blackout.

Redline below...

We also note, in the last paragraph, that The Fed appears to have gone cisgender - preferring to drop the 'man' from 'chairman'.

Bloomberg's Steve Matthews notes that the most meaningful part of the statement is the change on inflation, referring to it as declining and running below the FOMC's goal of 2 percent.

There's a clear but unstated view that the committee doesn't want to allow this to persist and is watching carefully.

Though not a big surprise, on the margin the wording seems dovish. There is a clear sense that the committee doesn't want this to go on forever, even though that's not stated. Powell will be asked what is the FOMC going to do about it.

As Bloomberg notes, a Fed hold could be music to the stock market's ears. Bespoke Investment Group notes that the S&P 500 Index's forward one-month returns after Fed meetings since 1994 have been best when the central bank has stood pat.

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