investment viewpoints
Federal Reserve Meeting – Balance-Sheet Mixes with Fed Rates
While investors widely expect the Federal Reserve (‘FOMC’) to leave interest rate policy unchanged this week at between 1.00% and 1.25%, most anticipate the Committee will announce the start of the reversal of quantitative easing and the reduction of its $4.4trillion balance sheet, given the highly publicised journey taken towards this point and Yellen’s recent speech at Jackson Hole.
With the FOMC having already announced the expected pace of reduction in its holdings of US Treasuries, agency bonds and MBS, purchases it made during the Recession and financial crisis of 2007 to 2009 to push down long-term borrowing costs and to stimulate the economy and credit markets, we believe there won’t be much further detail revealed this week, with no major decisions on the ultimate size of the balance sheet and its compositions.
The FOMC will also release the September update of the Summary of Economic Projection. Given incoming data, we expect only modest changes to the FOMC’s projection, with growth unrevised. We believe that, the FOMC will reduce its median inflation forecast for 2017 and 2018.
The main focus for markets will be on the changes to the interest rate policy forecast, in particular, the dot-plot in the Summary of Economic Projection. We believe the FOMC will maintain a rate hike this coming December, especially post the latest inflation report, and may introduce a more gradual hiking path for 2018-2019.
However, markets continue to underappreciate the need for continued policy normalisation in the US, with only 40bp of hike priced in by end-2017. While the FOMC is currently expecting about 100bp of hike over the period. Even if the FOMC were to revise its projected policy path lower, there continues to be an under appreciation by the markets for the need for higher interest rates in the US given the state of the business cycle. The latest developments in bond market pricing, as two to ten-year Treasury spreads narrow, indicates the FOMC could be pushing too hard to normalise monetary conditions.
important information.
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