Fed keeps rates steady, signals hike by year end

KEY POINTS:* The Fed said U.S. economic activity had picked up and job gains were "solid" in recent months

* Fed statement: "The case for an increase in the federal funds rate has strengthened"

* The committee had decided against raising rates "for the time being," until there was more evidence of progress toward its employment and inflation objectives

* Vote was 7-3, with dissents from regional bank presidents Esther George (Kansas City), Loretta Mester (Cleveland) and Eric Rosegren (Boston)

COMMENTS:

QUINCY KROSBY, MARKET STRATEGIST AT PRUDENTIAL FINANCIAL, NEWARK, NEW JERSEY:

"While the equity market enjoys the Fed's hold on a rate move, the two year yield has moved a touch higher suggesting that a December rate hike is in sight.

    "In the Fed's language, 'near term risks to the economic outlook appear roughly balanced.' This is about as close as you can get toward a commitment to a December hike."

DOUG DUNCAN, CHIEF ECONOMIST, FANNIE MAE, WASHINGTON:

"There's a pretty big dissent. There seems to be a pretty big discussion about the direction on rates. It's clear they want to raise rates in December if things don't deteriorate.

"I take the BOJ statement, which requires fiscal policy adjustments. BOJ is now the essentially the capital market of Japan. On the U.S. side, the Fed did what was expected.

"I think the dissent toward raising rates that there is a significant talk about making a move toward normalizing policy. They clearly made a downward adjustment on economic outlook and where rates should go. It's a recognition that there is a difference in the path of policies among the major central banks. Mortgage rates won't go very far from where they are now."

LUKE BARTHOLOMEW, INVESTMENT MANAGER, ABERDEEN ASSET MANAGEMENT, LONDON:

"It was pretty much a done deal that we weren't going to get a rate hike today. This meeting has really been about setting the stage for a December hike and what happens after that. The fact that three voters dissented is interesting, and it is pretty clear from the dots that the Fed plan on hiking in December this year as things stand. A December hike is by no means inevitable though. We've been in the situation before where the Fed has aligned their guns only to balk at the last minute. Between now and then there is the U.S. election of course. That could cause significant market volatility and deter the Fed. The simple expectation of a December hike could even be enough to cause a market selloff, which leads to the Fed putting its plans on ice in a self-defeating cycle."

FRITZ FOLTS, CHIEF INVESTMENT STRATEGIST, 3EDGE ASSET MANAGEMENT LP, BOSTON:

"No surprise on the Fed inaction. It could have been a contentious meeting, but we are seeing some measures of inflation."

    "The game continues and for now we can all focus on December. ... The central banks just don't seem to be able to extricate themselves so the story continues."

    "I'm sure there's strong disagreement in that room."

    "We have a reprieve for now .... We still like our broader themes. You do need to be in the equity markets. We're overweight ex-U.S. equities and based on what we've seen today those ex-U.S. equities seem to be doing well. ... There's less concern about the strong dollar sucking capital out of the perimeter, the emerging markets."

    "If you look at the BOJ and their move this morning we started to get this feeling that at least the Bank of Japan are realizing that low rates aren't helping growth as long as curves are flat ... We like that approach. We think that, OK, you might as well try this. The proof will be in the pudding."

STEPHEN MASSOCCA, CHIEF INVESTMENT OFFICER, WEDBUSH EQUITY MANAGEMENT LLC, SAN FRANCISCO:

    "It's as expected. I think the market will view it as good news. The body language makes it sound like they're warming people up for December. The dots are pretty clear pointing to that right now. As always this will be data dependent. If things stay the way they are today they've sort of telegraphed they're going to do something in Dec."

GENNADIY GOLDBERG, INTEREST RATE STRATEGIST, TD SECURITIES, NEW YORK:

"The three dissents, the fact that the risks to the outlook now appear roughly balanced and the fact that the case for the rate hike has strengthened, but they decided to wait, does show you their resolve to get rates off the ground later this year. Where the dovish offset is coming from, besides the fact they didn't actually hike, is the dots. The fact that the median for 2017 fell by more than one gives a dovish offset."

WILLIAM DELWICHE, INVESTMENT STRATEGIST, ROBERT W. BAIRD & CO., MILWAUKEE:

"It's pretty impressive that there were three dissenting votes. Clearly there are people on the FOMC that think the time to raise rates is now not later. That's a signal to the market to get ready for rate hikes."

"Looking at the dot plot I think all except three of the people who submitted projections look for rate hikes by end of 2016, so December would be logical place to do it."

* On the Bank of Japan: "They clearly feel like they need to do something to help their banks and they are trying to be creative in coming up with new ways to do it. I am skeptical that it will work, but kudos to them for being creative and trying to do something."

HEIDI LEARNER, CHIEF ECONOMIST, SAVILLS STUDLEY, NEW YORK:

"No surprise. It's interesting that the case for the rate hike coming this year wasn't a little bit more definitive. This is more lukewarm than I would have otherwise imagined in the absence of a move today."

ALAN RECHTSCHAFFEN, PORTFOLIO MANAGER, UBS, NEW YORK:

"I don't think anybody is too surprised. There was some noise that the Fed might surprise the markets, but this Fed doesn't really do that. This Fed likes to broadcast to the markets what its thinking is. Sometimes people in the market don't like to believe what the Fed is saying but this Fed has come through with its advertisements almost every time.

"You had the inaction, or the lack of new policy coming out of the European Central Bank and I think that gave a whiff to the market that the Fed might have something up its sleeve, that it might in fact raise rates. Then you had the dissenters of today's vote come out there and start to talk about the case for raising rates. But the fact of the matter is the leadership of the Fed – Janet Yellen and Stan Fischer - really have not changed their tune.

"There is the global question of how the new policies in Japan, all this accommodation around the world is going to impact that Fed and a lot of that is directly impactful on the dollar, but in the end it all goes back to 'is this economy getting better?' The economy is doing better in some areas, in employment, but even those numbers have softened a little bit since the last period. So we are on hold, I don't think they are going to do anything a few days before the election in November, then there is a real question of what the data tells us."

KARL SCHAMOTTA, DIRECTOR, FX RESEARCH AND STRATEGY, CAMBRIDGE GLOBAL PAYMENTS, TORONTO:

"Certainly we've maintained the status quo. This certainly is what was expected by most market participants. Now, we got some fairly clear hints here that the Fed will move by the end of the year. I think the key sentence here is the balanced expectations, where chair Yellen says risks are 'roughly balanced.' That would suggest that they see just as many upside risks as downside risks, and that's a watershed moment for the markets."

"I would expect in the next few minutes, you're going to see December hike probabilities pushing above the 50 percent mark, whereas going in we were sitting closer to 40 percent. This is going to provide a lift to the dollar to some degree, but certainly nothing dramatically in excess of what was expected.  I think the key here is that there was some possibility that we could see a hike today. That now has been taken off the table, so you're going to see some profit-taking on that basis. The other thing here is that we're seeing a slight downgrade in long-term interest rate forecasts. So essentially they've pulled down hike expectations by 2017-2018. What that implies is that while we do expect a liftoff in December, the rate hike path will be more gradual."

DENNIS DE JONG, MANAGING DIRECTOR, UFX.COM, LIMASSOL, CYPRUS:

"Fed Chair Janet Yellen has played her cards close to her chest of late, but today's decision to leave interest rates unchanged isn't going to cause shock waves in the markets. We are fewer than seven weeks from the presidential election, and with the financial data painting a mixed picture, the Fed has clearly decided upon a safety first approach. A second rate hike since 2006 does appear to still be on the agenda and, while the Fed's next meeting a week before the election may be too soon, December is looking the most likely timing for action."

MOHAMED EL-ERIAN, CHIEF ECONOMIC ADVISER, ALLIANZ, NEWPORT BEACH, CALIFORNIA:

"While the Federal Reserve held rates unchanged, the highly unusual 7-3 vote points to the depth of its policy dilemma and makes a December hike more likely."  

MARKET REACTION:

STOCKS: S&P 500 <.spx> last up about 0.25 pct, off of session high touched after statement

BONDS: 2- and 10-year Treasury yields fall from pre-statement levels

FOREX: Dollar weakens modestly, with the dollar index <.dxy> touching a session low, led by gains in the yen and euro RATE FUTURES: Little changed, December rate hike probability seen just over 50 pct

(Americas Economics and Markets Desk; +1-646 223-6300)