Reply #24: A closer look at that Fed statement [View All]

http://www.forexnews.com/AI/default.asp

The FOMC raised its fed funds rate by 25 bps to 2.25%, issuing a policy statement to the November statement.
The only exception of was more cautious assessment for the labor market conditions to which the FOMC described as "continue to improve gradually" from “have improved” in the November statement, in recognition of the soft 112K rise in November payrolls. That is in line with our note this morning when stating predicting “The only slight differences might be for the Fed to discreetly downgrade its assessment on labor markets from “improved” to something akin to “improved at a slower pace”, in recognition of the weak jobs creation in November creation and the higher than expected increase in weekly jobless claims".


At any rate, the discreet change is far minimal to the changes made in the November policy’s statement, which reflected a clearer amelioration in the Fed’s assessment from the September decision. Those changes included: 1) omitting the opening in the second sentence of the second paragraph stating, “After moderating earlier this year partly in response to the substantial rise in energy prices”, which indicated the Fed did NOT consider anymore the economy to have slowed as a result of rising energy prices. The other change was substituting: “appears to have regained some traction” with “output growth appears to be growing at a moderate pace”, which is also discreet improvement because it was not stated in the context of comparison to a soft patch.

There was no reason for the Fed to drop its “measured” reference to the pace way it removed liquidity nor a reason to sound off a more hawkish tone towards inflation. The Fed’s preferred measure of inflation as defined by core PCE price index, remained at or below 1.5% y/y over the past 5 months, well under the implied target of 2.0%. With the real fed funds rate still below 1.0%, the Fed is expected –and has signaled-to push rates towards the more neutral nominal territory of 3.75%-4.00%. Nonetheless, considering tepid job growth, a fading tax stimulus and still high oil prices, think the Fed will be required to justify such tightening.

Thus, although the dollar no longer lags behind in the league of yielding currencies, currency markets shall preserve their focus on the structural assessment of the US economy, namely the budget and trade deficits, accounting over 10% of GDP in aggregate. Worthy of note, is the rise in US bond yields following the this morning’s release of the record trade deficit, sending the 10-year yield to as high as 4.18% from Tuesday’s 4.16%. Such a move is a lucid articulation of the impending riskiness of holding US paper, through a higher required rate of return. And even though US CPI is inflation is at a comparable level to that of the Eurozone near 2.0%, 10-year yields stand at 4.14% well above their Eurozone counterpart.