Fed leaves rates on hold and balance sheet reduction is coming soon
The combination of balance sheet reduction and low inflation suggests there may not be another rate hike in 2017.
No surprises from the US Federal Reserve (Fed) with interest rates being left unchanged at the meeting on Wednesday. The statement contained some tweaks in wording with job gains now upgraded to “solid” and inflation is noted as “running below 2%”.
Meanwhile, balance sheet reduction (the unwinding of quantitative easing) is now expected to take place “relatively soon” for which read September.
Inflation poised to head lower
Investors saw the statement as dovish which probably stems from the inflation comment which contained no reference to temporary factors depressing the rate.
Consumer price inflation is likely to head lower in coming months and, whilst the core rate should stabilise, this will make further Fed tightening more difficult.
Market expectations are for the next rate rise to come in December once balance sheet reduction is underway.
Will the balance sheet unwind cause volatility?
However, this assumes that balance sheet reduction goes smoothly. We would note though that whilst the Fed plans to start slowly, the process picks up pace at a rapid rate. From an initial $10 billion per month the rate of unwind rises to $50 billion per month in just over a year.
In the absence of any guidance from the Fed as to where the balance sheet will end up, forward-looking markets could become concerned at the impact on liquidity and yields.
Greater financial market volatility would then cause the Fed to pause the unwinding of its balance sheet and probably defer further tightening.
Further rate hike this year looks unlikely
The combination of low inflation and balance sheet unwind suggests that we will not see another rate rise this year. Further tightening will then depend on inflation picking up and some fiscal boost. We expect both, but this will probably not be apparent in the data until later in 2018.
The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored.