The most important monetary policy decision is behind us. Yesterday, the Federal Reserve of the United States (the Fed) did nothing. And everything. 

It did nothing in the sense that it did not change the level of the federal funds rate, nor extended the Quantitative Easing (QE) program. While no one expected the Fed to lower the federal funds rate below zero, many expected an extension of the QE program to be announced. It did not, and from this point of view, the Fed was hawkish.

Yet, as it is often the case in monetary policy statements, the devil is in the details. Yesterday’s details painted an extremely dovish Fed, and the market acted accordingly.

At first, the USD rose across the board. On the realization that there is no QE extension, market participants bought the USD. That turned out to be the wrong decision, because at the press conference that followed, Jerome Powell, the Fed’s Chairman, better explained the Fed’s intentions.

Why Was the Fed Dovish?

The more Powell talked, the more the USD initial strength reversed. So strong was the reversal that the USD ended the day on its knees and today’s at the London’s opening, it made a new low. How come?

First, the Fed reopened the USD swap lines, albeit mentioning that this is just a temporary thing. For those involved in the markets back in March, when the stock market collapsed and the USD was rising, it was the Fed’s opening the USD swap lines with other central banks that eased the tensions and reversed the trend. By doing it again, the Fed signaled its dovish intentions.

Second, one of the key aspects of yesterday’s decision was to see if the Fed starts the so-called Operation Twist – buying long-term dated bonds to depress the yields even further. The Fed did not, but it said that it would if the need arises. In other words, it is a tool available for later use.

Third, and perhaps the key takeaway from yesterday’s press conference and decision, refers to the Average Inflation Targeting (AIT) regime. The market wanted to see if the Fed means business with its AIT shift – and it got what it wanted. The Fed kept the QE at $120 billion per month and vowed to keep it like this until a “substantial” improvement. How does one define “substantial”? By not putting an actual number on it, the Fed keeps the asymmetry of its reaction function in place.

All in all, the Fed chose a risky path to communicate its intentions. For some, the message was hawkish because of QE not being extended. But the market’s reaction says it all – the Fed moves to an AIT framework.