Global Daily – Fed balance sheet reduction to start in October

by: Nick Kounis

In this publication: Fed balance sheet reduction to start in October

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Fed balance sheet reduction to start in October

The FOMC decided to start to reduce its balance sheet next month by gradually tapering the re-investment of maturing assets. The Fed already published a detailed strategy of how it would do this in June. This schedule implies that the balance sheet will shrink by over USD 400bn by the end of next year. The decision to start the process next month and the strategy are as expected.

The Committee also decided to keep its target range for the fed funds rate at 1-1.25%. At the same time, the median view of the Committee remained that the target range would need to rise by another 25bp this year, and another 75bp next year, in line with the view set out in June.

The FOMC remains confident in the inflation outlook over the medium term despite the weak inflation trends see recently. Indeed, although the median core PCE inflation projection was revised lower in 2017-2018, it maintained the view that it would be back to 2% in 2019.

The unchanged projections for the fed funds rate suggest that the FOMC is more inclined to raise rates than financial markets had expected. This led to a jump in US Treasury yields and the dollar as financial markets raised their view of the likely path of short-term interest rates upwards.

We are also surprised by the FOMC’s ongoing confidence in the medium term inflation outlook and desire to raise interest rates again this year. We stick to the view that the FOMC will wait until March 2018. This reflects that the trend in inflation may well continue to disappoint, while the voting members of the Committee have a more dovish view than the overall FOMC. Nevertheless, the chances of another rate hike this year have clearly gone up. (Nick Kounis)