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Fed looks set to move in December...maybe

Janet Yellen
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The Fed is pointing to a December hike, unless the economy fumbles or markets are roiled by overseas events or even the U.S. election.

"I think they're setting up for December, unless things go off the rails. Now there are three dissenters, and I think that's pretty unusual, and it shows you they are really ready to go," said John Canally, economist and market strategist at LPL Financial.

The Fed held rates steady on Wednesday but said the economy had improved and indicated it is closer to hiking interest rates.

The three officials who dissented over the Fed's decision to keep rates unchanged were Cleveland Fed President Loretta Mester, Kansas City Fed President Esther George and a new voice in the hawk chorus — Boston Fed President Eric Rosengren.

"They would like to go in December. Rosengren's dissent is interesting. ... He's worried about financial stability aspects of keeping rates low, to the point where he's willing to dissent," said John Briggs, head of strategy at RBS.

Stocks initially pulled back, then moved up and down, but were at highs of the day in late trading. Treasury yields retreated, including the Fed sensitive 2-year note, which fell to 0.77 percent from a high of 0.81 percent earlier. The 10-year yield fell to 1.66 percent.

"They said the risks are balanced, which is interesting, and they're preparing markets for a tightening in December, unless something goes off the rails ... like Brexit goes off the rails, China goes off the rails or the election. That could be one of the things," said Canally.

Economists had mostly expected the Fed to hold off until December, particularly since the November meeting will be close to the election and the Fed does not hold a press briefing that month. December of last year was when the Fed first hiked rates from zero. It was the first rate hike in nearly a decade.

Fed Chair Janet Yellen, in a press briefing, said the Fed believes that while it is confident in the economy, labor could continue to make progress and inflation is below its target, though the Fed expects it to rise.

"I think that this was a place holder meeting. Her body language was pretty much like this was a close call. 'We just need to gather a little more evidence.' You could tell she was on the defensive here. There is a growing group of dissenters on the committee so I think December is quite likely," said Ethan Harris, co-head of global economics research at Bank of America Merrill Lynch.

Soft economic data in August also had convinced many Fed watchers that the Fed would stay sidelined until it sees more evidence of an improving economy.

"They're trying to look past the weakness from earlier this month when they said economic activity has picked up from the modest pace seen in the first half of the year. I think they're hoping the data will give them cover to go in December," said Briggs. He said Fed futures initially jumped to 62 percent odds for a December hike, but fell back after a few minutes.

J.P. Morgan chief economist Michael Feroli said important in the Fed statement was that it noted that the case for a rate hike has strengthened.

The Federal Open Markets Committee also said it would await "for the time being" further evidence of continued progress toward its objective. "The phrase 'for the time being' is obviously somewhat ambiguous; a case could be made that this points to November, though we still think the odds for a hike at that meeting remain well below 50 percent," Feroli wrote.

In an interesting contrarian view, Barclays, one of the few firms to expect a September hike, said it now sees even the chance of December in doubt.

Barclays economists pointed to the dissent on the board and the fact that it is split.

"…with three members dissenting against the decision and three, presumably different, members calling for no further rate hikes this year, the committee is more split than it has been at any time in our memory," they wrote in a note. "This split in views will make FOMC communication and action increasingly difficult this year. In particular, we believe that this level of dissent will make it difficult for the committee to keep the possibility of December rate hike live in the minds of market participants and, indeed, households and businesses."

Ron Sanchez, CIO of Fiduciary Trust, said the Fed didn't surprise the markets much, and it did lower the trajectory of rates, as expected.

The Fed's 'dot plot' showed it now expects one rate hike this year, instead of the two it had previously forecast. He said the range of Fed officials' forecasts is wider for fed funds next year – 1.1 percent to 1.8 percent, so the path is lower and the median is for two hikes.

He said a positive is that the Fed did not change the long term rate for Fed funds by much, lowering it to 2.875, after reducing it more deeply in June from March's 3.5 percent.