The Federal Reserve Board's FOMC meeting today didn't offer anything new on the projected path of interest rate hikes, but it did officially end its asset purchase program. We review the latest FOMC Statement below, but we also excerpt from a recent Fidelity report entitled, "Money Markets: Both Doves and Hawks Find Fed Support." Fidelity writes, "The Federal Reserve's post-FOMC (Federal Open Market Committee) meeting press conference in September included comments that supported the outlooks of doves and hawks alike. Doves noted the ongoing use of the words "considerable time" in the Fed's statement, referring to the period in which federal funds will likely remain in their current range after the asset purchase program ends. Investors have generally defined the term to mean a period of "at least six months" before the first interest rate hike, basing their belief on comments made by Chair Janet Yellen earlier this year."
"In contrast, the hawks pointed to the FOMC's median rate forecasts depicted by the survey of economic projections (SEP), or "dot chart," which moved materially higher. The Fed's policy rate forecasts out to 2017 were also released for the first time, giving investors more to evaluate," states the report, penned by Nancy Prior, president, Fixed Income; Michael Morin, director, Institutional Portfolio Management; and Kerry Pope, institutional portfolio manager.
They continue, "Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser voiced their disagreement with the most recent Fed guidance, dissenting at the most recent FOMC meeting. Both men have been ongoing critics of the Fed's accommodative policy and believe that the Fed's pledge for "considerable time" indicates too long a period before rates will need to be raised. Mr. Fisher is expected to step down next year and Mr. Plosser announced his plans to retire in the spring. In contrast, a speech given by New York Fed President and Vice Chairman William Dudley was interpreted as dovish. In addition to saying that he saw liftoff occurring around mid-2015, Mr. Dudley spoke about the dollar's strength putting downward pressure on U.S. inflation and dampening the near-term outlook for U.S. exports. Both of these, he said, keep the Fed patient about raising rates, even with the labor market strengthening. Additionally, despite the stronger-than-expected September labor report, Mr. Dudley also stated that he saw "significant underutilization" of labor market resources."
The Fidelity report also commented on a noteworthy end to the third quarter. "The money market landscape changed in September with the announcement of important changes to the Fed's overnight reverse repurchase agreement operation (ON RRP). As of September 22, 2014, the minimum bidding size available to participants was raised to $30 billion from $10 billion, and the Fed imposed a $300 billion aggregate daily cap. Once the cap is reached, the Fed will conduct a Dutch auction, a bidding process in which the lowest rates submitted are accepted until the cap is reached. At that point, all those bidding at the highest yield accepted at the auction -- known as the "stop-out rate," or "stop" -- or below are awarded their respective bids at the stop-out rate. The new ON RRP parameters were put to the test with money market supply imbalances exacerbated by quarter end. At quarter end, the $407.176 billion of bids submitted by investors to the ON RRP facility handily surpassed the $300 billion aggregate cap. Participant bids ranged from five basis points to negative 20 basis points, and were filled at a stop of 0.0%."
They also discussed the impact of money market reforms on portfolio management. "Planned modifications to Rule 2a-7 are already causing fund sponsors to increase their seven-day liquidity thresholds. While Fidelity's institutional funds have always targeted liquidity thresholds well above the 30% level, growing demand for high quality liquid investments from fund sponsors and banks are keeping short-term rates suppressed. In order to efficiently maintain our conservative liquidity thresholds, Fidelity expanded the number of seven-day transactions with banks that represent minimal credit risk. Fidelity's funds also took advantage of the higher rates available in the longer end of the money market curve, as the potential for a rate hike in mid-2015 was factored into security prices."
Finally, Fidelity writes, "Our term purchases included floating-rate notes with maturities of six months or longer, high quality fixed-rate issuers in the four- to nine-month range, and agencies and supranationals in the 12- to 13-month range. Looking forward, inflation should remain well contained, perhaps even declining from current levels, because of the effects of global headwinds and a stronger U.S. dollar. This should support a cautious attitude on the part of the Fed as it considers raising interest rates. Also weighing on short-term rates is the continued supply imbalance of money market instruments, which is not expected to abate in the near future. Against this backdrop, we will continue to emphasize the preservation of capital and liquidity while taking advantage of opportunities in term investments."
Jumping to the most recent FOMC meeting on October 28-29, the Federal Reserve did end its asset purchase program after 2 years. The Fed's Statement says, "The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions."
As expected, there was no change in interest rate policy. "The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. However, if incoming information indicates faster progress toward the Committee's employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated."
