FOMC: “Some” small steps toward September

The FOMC made relatively few changes to their July statement, noting better data on net since June, and suggesting progress toward the conditions for liftoff. The FOMC now is looking for just "some further improvement" in the labor market. This qualification is marginally hawkish, as it constrains what had been a more open-ended set of conditions to start hiking. That said, policy remains data dependent, with two employment reports - plus a host of other data - between now and the next meeting on September 17. The base case remains a September liftoff, with a marginally higher probability than before today's meeting. But the timing of liftoff is not certain, thanks to data dependence and the range of views on the FOMC regarding the appropriate timing and pace of normalization.

In the opening paragraph of the July statement, the FOMC noted that activity continued to expand "moderately." Most importantly, the labor market "continued to improve," with slack diminishing since the start of the year. Housing showed "additional improvement" while consumer spending was "moderate;" capex and trade "stayed soft." On net this reflects a modest improvement in the activity data since the June meeting. 

The FOMC also dropped mention of oil prices, as they no longer appear as stable as in June. However, there were no changes to the inflation outlook: it is still seen gradually converging to target over time. Similarly, there was no explicit mention of a reduction in global uncertainty or change in the balance of risks, as some in the market had speculated. The updates were relatively small overall, but in a more positive direction that keeps September very much a "live" meeting

Other than qualifying the hiking criteria as requiring "some further improvement" in labor market conditions, the FOMC literally made no other changes to their policy language. In particular, they still say they need to be "reasonably confident" in the inflation outlook to hike, and still characterize the strong US dollar and drop in energy prices as only "transitory effects" that will "dissipate" with time. The improving labor market remains key to the Fed's forecast to gradually reach their 2% inflation target. Rates investors looking for a clearer policy signal received little satisfaction today. There was an initial modest bull steepening of the rates curve. The market is pricing in about an 8.5bp increase in the funds rate by the September meeting. 

"Given our forecast for liftoff in September, we remain biased short the front end. However, the recent selloff in front-end rates since the Greek resolution has made risk-reward more neutral relative to early July," says BofA Merrill Lynch.