FOMC Rate Decision | SEP | Powell's Press Conference - all about being more confident| Avoid Sep 19 Money Market Stress| BS run off to taper "fairly soon"

The FOMC policy is out of the way. Let's recap the Fed Rate decision, key pointers from the Post Policy Conference and what I'm think about the Fed Policy going forward.

Interest Rates were left unchanged 5.25% - 5.50%

The Summary of Economic Projections showed 2024 GDP Growth being revised higher while U/R was revised 10 bps lower and Core PCE Inflation was revised 20 bps higher while leaving the FFR projections unchanged at 4.6%. Interestingly, the projections for 2025 and 2026 FFR were both revised 25 bps higher and a 10 bps increase to the longer run neutral rate. The longer run neutral rate was revised higher for first time since June 2022 - Is it a tacit acknowledgement by the Fed that Neutral Rates have moved higher as markets have been talking about it all along. There are 9 officials who see longer run FFR above 2.5% compared to 2 in the June 2022 policy.

Refer to the table below for forward and long term projections.

Interesting in the table above is the Implied Market Pricing of Fed Fund Rates

While the market pricing is more or less in line with Fed's Dot Plot for 2024 and 2025, there is a significant divergence in 2026 and Longer Run pricing. The market is pricing in higher longer run rates and if the Economic Resilience of US holds , we could be in for higher rates and higher term premia. 

On the Balance Sheet run off, Fed Chair acknowledged the FOMC's consensus to taper the pace of run off. He also pointed out that reducing the pace of run off should not be judged as the reduction of balance sheet to levels lesser than earlier estimates but a smoother approach to mitigate stress in money markets and aiding the gradual decline towards an appropriate level of "AMPLE RESERVES". 

Powell's press conference held some important insights around:

Inflation - Chair Powell sounded fairly confident on achieving 2% inflation

Timing of relief on housing inflation is uncertain but there is confidence that lower rent increases will show up in measures of inflation overtime. Good price inflation is likely to come into better equilibrium (since Jun 23, durable gds prices have been falling mom for 7 consecutive months) and a decline in non housing services should bring inflation sustainably to 2%.

The elevated Jan inflation prints could be on account of one off seasonal factors. The extent of disinflation in the latter part of the year would be impacted by low base effect.

Employment - Strong Job growth is a not a reason in itself to hike. However, unexpected Significant weakening in employment data could be a catalyst for cutting rates.  If layoffs were to increase that would mean fairly quick increases in unemployment. 

Balance Sheet Run Off - Fed was dovish as Chair Powell spoke about slowing the pace of BS run off fairly soon as Fed clearly wants to avoid a repeat of the 17 Sep 2019 episode when SOFR increased to above 5%. The below table shows the balances in the ORRP facility and Reserve Balances

What we picked from the Press Conference on BS run off ?

Time -  Slow the pace of Balance Sheet run off fairly soon 

Rationale - "Liquidity is not evenly distributed in the system. And there can be times when in the aggregate reserves are ample or even abundant, but not in every part. And those parts where they’re not ample there can be stress. And that can cause you to prematurely stop the process of BS reduction to avoid the stress. And then it would be very hard to restart." Once the overnight reverse repo facility drops close to zero , reserves will likely decline at the same pace as that of the BS. 

Scope - The pace of MBS run off has been muted as higher mortgage rates have reduced prepayments  - $ 16 bn over the last 6 months. Longer run goal is to return to a balance sheet that is mostly Treasurys. 

What is the Fed watching to inform Decisions - Federal Reserve is paying a lot of attention to how money markets are behaving, where Federal Funds Rate and Secured Funds Rate is trading relative to administered rates (Interest on Reserve Balances & RRP Rates). And there is not a set formula say % of GDP rule or absolute USD amount which defines "Ample Reserves". 

Markets have been estimating guiding posts for Fed Balance Sheet actions with broad consensus seeing ONRRP Reserve Balances moving towards zero and ballpark $3.1 trn in Reserve Balances as a condition for stopping balance sheet run off. 

Pre-FOMC Implied FFR market pricing was seen at 73 bps which moved to 86 bps post policy.

To sum it up, Fed continues to be data dependent - Labor data and Inflation readings will dominate narratives and a tapering of the BS run off is fairly soon which to me is incrementally risk positive. Higher base effect play into the second half of the year could stall the disinflation progress.