The FOMC maintained its target range for the federal funds rate at 2.25%-2.50% but stated that will be patient and flexible in its interest rate approach. The Committee also announced that they are prepared to adjust the balance sheet normalisation plan. While the FOMC may have turned dovish due partly to the on-going global and domestic political and policy uncertainty in 1Q2019, we opine that should there be some resolution on these policy fronts, the Fed may resume their gradual interest rate increase in late 2Q2019.

DATA HIGHLIGHTS

As anticipated, the FOMC maintained the target range for the federal funds rate at 2.25-2.50%. However, it sounded more dovish as the Committee stated that it will be patient and flexible.

Overall, the FOMC remained positive on the domestic economy as it said that economic activity has been rising at a solid rate from previous statement of strong rate. Job gains have been strong, and the unemployment rate remained low. The Committee said that household spending continued to grow strongly. Meanwhile, business investment has moderated from its rapid pace earlier this year. On inflation, the Committee noted that overall inflation and inflation for items other than food and energy remained near 2%. In this meeting, they stated that market-based measures of inflation compensation have moved lower in recent months, while survey-based indicators remained the same. While the FOMC continues to expect strong labour market conditions and inflation to remain near the 2% objective as the most likely outcome, it pledged to be patient and flexible. In line with this, the FOMC has also announced that the Federal Reserve is prepared to adjust any of the details for completing balance sheet normalisation in light of economic and financial developments. They also stated that the Committee is prepared to use its full range of tools including balance sheet to warrant a more accommodative policy stance.

2018 GDP was maintained at 3.0% while 2019 GDP at +2.3% YoY, still higher than longer-run rate of +1.9%. Unemployment forecast in 2018 was retained at 3.7% and remained constant at 3.5% in 2019. Forecast for 2018 PCE deflator was at 1.9% YoY and expected to remain steady at +1.9% YoY in 2019. In line with the slight downgrade of PCE, core PCE deflator forecast was also pared down to 1.9% YoY but expected to trend slightly higher to +2.0% YoY. For 2019, FOMC members’ projection of fed fund rate was at 2.9%, indicating the FOMC is expected to raise the fed fund rate by 2 times in 2019. In 2020, the Committee maintained its projection to increase the policy rate by 1 time. On the estimated neutral rate, the FOMC gauges it to be 2.8%, lower than previous period.

HLIB’s VIEW

The FOMC decision to maintain the policy rate was in line with our expectations. However, the FOMC’s stance to be patient on its interest rate policy (previous: some further gradual increases) and the Committee’s statement that it is prepared to adjust the balance sheet normalisation in the future (previous: balance sheet adjustment on autopilot) implied the Fed has turned more dovish. As a consequence, US equity markets surged, dollar weakened and 10 year – 2year bond yield curve steepened. We opine that the outlook in 1Q2019 is fraught with downside risks (US China trade talks, US fiscal challenges, Brexit), with possible negative implications on financial and economic activity. This could be one of the reasons for the dovish tone from the FOMC statement. However, should there be some resolution on these policy fronts that leads to continued economic activity, we opine there is a possibility the Fed may resume their gradual interest rate increase in late 2Q2019.

Source: Hong Leong Investment Bank Research - 31 Jan 2019