United States: Fed holds firm in September as it readies to begin balance sheet unwinding
September 20, 2017
At its 19–20 September meeting, the Federal Reserve’s Open Market Committee (FOMC) maintained its target for the federal funds rate at between 1.00% and 1.25%, as widely expected by market analysts. The Committee also announced that it plans to begin unwinding its massive USD 4.5 trillion balance sheet in October, the details of which were in line with what the Fed had previously communicated.
The FOMC struck a largely hawkish tone in the meeting as officials continued to downplay low inflation. Although the statement acknowledged sustained weakness in headline and core inflation, the Fed’s “dot plot”—which charts FOMC members’ expectations for future policy rates—was unchanged for the short term, with a majority of members still expecting a third rate hike before year-end. In the press conference that followed the meeting, Fed Chair Janet Yellen argued that weak core inflation data this year “primarily reflects developments that are largely unrelated to broader economic conditions”. This surprised some market participants, who had expected the Fed to temper its short-term outlook as it waits for inflation to regain traction. The announcement sent both U.S. Treasury yields and the U.S. dollar higher.
The “dot plot” was also kept unchanged at three hikes next year, further confirming the Fed’s current bias towards labor market data over inflation data. However, the median estimate for the interest rate fell to 2.7% for 2019, down from 2.9% previously—again suggesting two rate hikes in 2019 against the three previously expected. The longer-term median interest rate projection also decreased to 2.8% from the 3.0% previously forecast. This suggests that the Fed has become less optimistic on how much the natural rate will increase in coming years as a result of productivity growth.
Regarding the economy, the statement that followed the meeting was largely unchanged from the previous one. The FOMC noted continued strength in the job growth and a pick-up in investment activity. The Committee recognized the negative short-term effects on growth from recent major hurricanes, but officials do not expect these effects to last or to alter the current path of growth. In fact, the Summary of Economic Projections (SEP) showed a slightly more upbeat economic outlook for this year; median GDP growth was upgraded by two-tenths of a percentage point to 2.4% (previously reported in June: +2.2% year-on-year). The outlook remained unchanged at 2.1% for 2018. The SEP also lowered the unemployment rate forecast by one-tenth of a percentage point for both 2018 and 2019, to 4.1%.
The FOMC also disclosed its plans to begin its balance sheet runoff in October. The Fed will gradually cease re-investment of maturing holdings, capping them at USD 6.0 billion a month in U.S. Treasury bonds and USD 4.0 billion a month in mortgage-backed securities. These levels are expected to be raised at three-month intervals until they reach USD 30 billion and USD 20 billion, respectively. Chair Yellen suggested that the hurdle for ending the unwinding is high, as the Committee will only consider resuming asset purchases if an economic downturn warranted greater accommodation than interest rates can provide.
Author: David Ampudia, Economist