As expected, the Federal Open Market Committee (FOMC) on Wednesday left short-term rates unchanged. The target range for the federal funds rate is still 2.25% to 2.5%.
The Federal Reserve’s post-meeting statement was updated to reflect that the committee will take a “patient” approach to future policy changes. The central bank also indicated that it may be more flexible with its balance sheet normalization process in the future.
Bond yields fell on expectations for a slower future pace of hikes, while stock prices rose.
As expected, the Federal Reserve on Wednesday kept its key short-term interest rate steady, maintaining the 2.25% to 2.5% target range for the federal funds rate.¹ The decision was unanimous.
However, although the rate was left unchanged, updates to the Federal Open Market Committee (FOMC) statement had a more “dovish” tilt, indicating that the pace of rate hikes going forward may be slower than initially projected. Bond yields fell and stock prices rose after the meeting on expectations that the pace of rate hikes will slow, easing upward pressure on bond yields and helping to keep financial conditions more accommodative to economic growth.
Included in the FOMC statement was a remark that the committee “will be patient as it determines what future adjustments to the target range for the federal funds rate” are appropriate.2 Meanwhile, the previous reference to the committee’s judgment that “some further gradual increases” were warranted was deleted from the text of the statement.
This underscores comments made by various Fed officials since the December FOMC meeting that suggested future rate decisions would be dependent on economic data, that monetary policy was not on a predetermined course, and that rate increases would be on hold for longer than previous FOMC projections indicated.
Balance sheet normalization not on autopilot
The Fed also released a statement on Wednesday regarding its balance sheet normalization process, highlighting that the committee “is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program.” 3
This contrasts with Fed Chair Jerome Powell’s comments at the December 2018 press conference, in which he indicated that the balance sheet normalization was on autopilot. While many officials, including Powell, have attempted to walk back those comments, this is the first official FOMC statement clarifying the matter.
Bond prices rose and yields—which generally move inversely to bond prices—dropped, with short-term Treasury yields falling more sharply than longer-term Treasury yields.
The two-year Treasury yield dropped by roughly five basis points (one basis point is 1/100 of a percent, or 0.01%) on expectations for a modestly slower pace of rate hikes. Short-term Treasury yields are more sensitive to Fed policy than longer-term Treasury yields, which tend to be driven more strongly by expectations for longer-term economic growth and inflation.
Meanwhile, stock prices rose sharply following the conclusion of the meeting, as a slower pace of rate hikes helps keep financial conditions more accommodative and helps keep corporate financing costs low.
Market expectations for the pace of rate hikes fell as well—according to Bloomberg, the implied probability of a rate hike this year fell to just 14%, while the probability of a rate cut actually increased. But despite declining expectations, the Fed may still continue to hike rates this year—a slower pace of rate hikes doesn’t necessarily mean no rate hikes.
Takeaways for investors
A more patient approach for Fed rate hikes may mean that bond yields rise only modestly from here. The Fed may raise rates one or two more times this year, but upcoming economic data will be important. If inflation remains below the Fed’s 2% target or the job market shows signs of cooling, a longer pause may be warranted.
While the yield curve modestly steepened on Wednesday, we ultimately expect the yield curve to flatten if the Fed does continue to slowly raise rates.
¹ The federal funds rate is the interest rate at which depository institutions, such as banks and credit unions, lend reserves overnight to other depository institutions.
2 Board of Governors of the Federal Reserve System, “Federal Reserve Press Release,” January 30, 2019
3 Board of Governors of the Federal Reserve System, “Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization,” January 30, 2019
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