Global Daily – Fed completes its dovish shift

by: Bill Diviney

Fed View: FOMC barely retains its tightening bias – The FOMC kept rates on hold yesterday, but surprised to the dovish side by signalling no rate hikes in 2019, and announcing an end to its balance sheet runoff this September (in line with our expectation; consensus was for Q4 – see details below). While the move supports our view that the Fed is done with rate hikes this cycle, the removal of both 2019 hikes came as a surprise to us. With today’s dot plot, the Fed just about retains its tightening bias, but only by a whisker – with one 2020 rate hike, and policy on hold in 2019. In the press conference, Chair Powell continued to sound rather dovish, again referencing the global slowdown (particularly in China and Europe), but also noting the ‘mixed’ incoming data the US is seeing in 2019 so far. Indeed, the FOMC once again downgraded its 2019 growth forecast to 2.1% from 2.3% in December, bringing its view closer to our own expectation of 2.0% (Q4/Q4 year-on-year rates; our annual average growth forecast is 2.3%). Despite the dovish moves today by the Fed, we continue to view rate cuts as unlikely in our forecast horizon (to end 2020). Following the decision, however, market pricing moved further in the direction of rate cuts, with 9bp in cuts now priced in by year-end, up from 6bp previously. As such, there is scope for a repricing given the Fed’s dovish shift is now likely complete.

Quantitative tightening to end this September – In line with our view, but a bit sooner than consensus (Q4). The Fed will begin tapering its balance sheet runoff from May by halving the US Treasury component (currently USD30bn per month) while keeping the Agency component (USD20bn) intact. As such, the total runoff will be USD35bn per month from May-September, down from USD50bn currently. After September, the Fed will continue to allow USD20bn in Agency securities to run off per month, but for this to be reinvested in US Treasury securities, thereby shifting the composition back towards government bonds. All told, this should take excess reserves to around USD1.2trn by September, with an overall balance sheet size of c.USD3.7trn down from a peak of USD4.4trn before the runoff began in October 2017. As a share of GDP, the Fed’s balance sheet will have fallen from a peak of 24.9% in early 2015 to c.17% of GDP by end-2019. (Bill Diviney)