1. Federal funds rate increased to 1.25 percent
The Federal Open Market Committee has raised its benchmark rates by 0.25 percent, to between 1 percent and 1.25 percent. This is in line with market expectation. However, the main focus of the 14 June FOMC meeting was on the trajectory of the rate hikes and the plan of the winding down of the FED balance sheet.
2. One remaining hike in 2017 and three more in 2018
Looking at the dot plot of the expectation of the Fed targeted funds rate, median expectation of the rate for 2017 is at 1.25% – 1.50%. This would suggest another rate hike before the end of 2017. In addition, we should be expecting 3 more rate hikes in 2018 to reach the median expectation of 2.0% – 2.25%.
Fig 1: Median expectation of funds rate indicates one more rate hike for 2017
Source: FOMC Economic Projection
3. Exit strategy of the Fed balance sheet
The plan for the unwinding the Fed balance sheet (or the reversal of QE) was finally laid out in black and white.
The plan for the unwinding the Fed balance sheet (or the reversal of QE) was finally laid out in black and white. For U.S. TreasuriesTrimming reinvestment in Treasuries with a cap of US$6bn per month for
For U.S. Treasuries
Trimming reinvestment in Treasuries with a cap of US$6bn per month for a period of 3 months before increasing the cap in steps of US$6bn at three-month intervals over a period of 12 months until it reaches US$30bn per month.
For Mortgage-backed securities (MBS)
Trimming reinvestment in agency debt and MBS with a cap of US$4bn per month for a period of 3 months before increasing the cap in steps of US$4bn at three-month intervals over a period of 12 months until it reaches US$20bn per month.
In aggregate, the Fed expect to trim US$10bn per month off their balance sheet initially and build up to US$50bn per month by the end of 12 months.
However, the plan came with a caveat.
“Provided that the economy evolves broadly as anticipated”, as stated in FOMC statement.
After the implementation of the normalization of the balance sheet, it is anticipated that the balance sheet of the Fed will be at a level appreciably below that seen in recent years but larger than before the financial crisis.
4. Fed lower inflation expectation for 2017
Inflation will be a key concern in the months to come as inflation data fell short of expectations over the past three consecutive months. As such, the FOMC’s inflation forecast for 2017 was lower.
PCE inflation was revised down to 1.6% from 1.9% while PCE core inflation was revised down to 1.7% from 1.9%.
Our thoughts on the tightening monetary policies
On the back of a series of weakening economic data release, we felt that it was not the optimal time for Janet Yellen and co. to announce their normalization plan for the Fed balance sheet. Retail sales and inflation data which were released earlier on the same day, clearly show some sign of weakness.
However, the labor data have been solid and might prove to be the catalyst for the Fed to follow through with their plan to normalize their balance sheet. The unemployment rate is at a record low.
In conclusion, we felt that there were no strong reasons for the FOMC to delay the normalization of the Fed balance sheet. Inflation will be a key data to watch out for in the coming months as further weakness in inflation may potentially stall the normalization plan of the FOMC.
Changes in the FOMC Statements from May 2017 to June 2017
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Sai Teng covers the global macro research. He has more than 6 years investment experience primarily in portfolio construction and asset allocation. He graduated with Bachelor of Science in Banking and Finance from University of London.
