Breaking: Fed leaves policy rate unchanged, doubles pace of bond taper from mid-January

• The Fed left interest rates unchanged at 0.0-0.25% and doubled the pace of QE taper in January, as expected. 
• The bank's new dot plot showed Fed members expect three rate hikes in 2022, more hawkish than some had expected. 
• As a result, the US dollar was supported and the DXY lurched towards 97.00. 

The US Federal Reserve announced on Wednesday that the FOMC had agreed to leave the Federal Funds target range unchanged at 0.0-0.25%, in line with expectations. Moreover, the pace of the taper of the bank’s bond-buying programme will be doubled from mid-January to $30B per month, with a similar pace of taper likely appropriate in the months thereafter, though the pace of taper could be adjusted if warranted by a change in economic conditions. If the Fed does reduce its bond-buying by $30B per month until the programme is fully unwound, net asset purchases will fall to zero before the end of March 2022.

According to the new dot plot, the median view of the Fed Funds rate at the end of 2022 was lifted to 0.9% (indicating three rate hikes are expected in 2022) from 0.3%. The median view of the Fed Funds rate at the end of 2023 and was lifted to 1.6% from 1.0% and at the end of 2024 was lifted to 2.1% from 1.8%. The Fed’s view of where interest rates will sit in the long-run was left unchanged at 2.5%. Five of the 18 Fed members see the policy rate at or above 2.5% by the end of 2024. 

In its statement on monetary policy, the Fed said that, with inflation having exceeded 2.0% for some time, its expects it to be appropriate to keep interest rates at the current level until labour market conditions hit levels consistent with full employment. The Fed added that supply and demand imbalances related to the pandemic and economic reopening continue to contribute to elevated levels of inflation and that risks to the economic outlook remains, including new variants of Covid-19. Job gains have been solid in recent months, the Fed said, and the unemployment rate has declined substantially, though sectors most adversely affected by the pandemic have improved in recent months, though continue to be affected by the pandemic.  

The Fed also released new economic forecasts, where it sees Core PCE averaging 2.7% in 2022, up from 2.3% in the last forecast, before falling back to 2.3% in 2023 and then to 2.1% in 2024. The GDP growth forecast for 2022 was revised slightly higher to 4.0% from 3.8%, and was left unchanged at 2.2% for 2023 and 2.0% for 2024. The long-run expectation for growth was left unchanged at 1.8%. 

Market Reaction

The DXY initially spiked higher from the 96.60s to as high as 96.90 in response to the Fed's policy announcement but has since retraced lower to the 96.70 area. USD/JPY broke above 1.1400, taking it to fresh one-month highs. EUR/USD fell sharply under 1.1250 and to fresh one-month lows in the 1.1220s.

The dot plot seems to have been a little more hawkish than expected, with three rate hikes indicated in 2022 (some market participants had expected the Fed to signal two hikes in 2022). As traders continue to digest the announcement, FX market focus now turns to the post meeting press conference with Fed Chair Jerome Powell, which kicks off at 1930GMT.