US Fed seen staying on track for December rate increase

US Fed seen staying on track for December rate increase”

The Federal Reserve will start trimming a balance sheet next month that ballooned to $4.5 trillion as it invested in capital markets to buoy the USA economy after the 2008 financial crisis. Banks benefit from higher rates, which can translate into higher profits from lending money. It is expected that they will announce a start date for the plan to reduce the balance sheet.

The announcement marks a milestone in the long recovery from 2008, and reflects confidence by Fed officials that the economy will continue to grow. Still, no one is sure how the financial markets will respond over the long run.

Indeed, the Fed has raised short-term rates only four times, to a current range of 1% to 1.25%, since cutting them to almost zero during the crisis. "They might have to scale back on how aggressively they raise rates over the next couple of years". Restoring the Fed's giant, $4.5 trillion portfolio of bonds and other assets, still bloated from the financial crisis, to normal levels. Given the underlying instruments - Treasuries and agency mortgage-backed securities - it would appear that a balance sheet unwind announcement should help buoy long-end USA yields.

In June, the Fed spelled out its plan for shrinking the balance sheet: It would let a small portion of bonds mature each month without being replaced. Financial conditions also remain loose across the United States, and long-term interest rates have fallen recently, factors that strengthen the argument that another rate hike would not slow the economy. "They don't want to flood the market with bonds which will drive bond prices down and then people will sell out of the market as well if it drops", Melissa Armo, trader and founder of The Stock Swoosh, told FOX Business. In turn, widening interest rate differentials and a steeper yield curve, over time, should help the US Dollar stabilize and break its 2017 downtrend. With Hurricanes Harvey and Irma clouding some economic data - temporarily raising gas prices, likely restraining hiring and potentially depressing growth in the July-September quarter - some analysts assumed the Fed wouldn't have enough information by December to assess whether the economy had rebounded from the storms. The unemployment rate is just 4.4 percent, near a 16-year low. A critical question is whether the Fed has grown troubled or confused about chronically low inflation.

Axa Investment Managers senior economist David Page noted that in the press conference accompanying the announcement, Fed chair Janet Yellen stressed that the unwinding of the balance sheet was not considered an active policy tool and that the FFR would remain the "go to" policy lever.

"REAL DESIRE' Although the Fed has been troubled by the drop in USA inflation, Yellen and other officials have attributed it to short-term factors, such as changes in cellphone plan pricing, that should diminish in the coming months".

However, she cautioned, "The fact that inflation is unusually low this year does not mean that that's going to continue".

"Keeping rate hikes where they were was expected". The June "dot plot" had pointed to three rate increases for 2017.

Yellen pointed out that if the Fed didn't withdraw its monetary stimulus, the economy could overheat and the inflation could move up more rapidly, in view of the continued labor market tightening. She will certainly be asked.

"At least over the near term, probably between now and the end of October, the market is at risk", he said.

President Donald Trump has indicated that he is considering asking Yellen to serve another term.

Other names being floated: Glenn Hubbard, dean of Columbia University's business school; John Taylor, a professor at Stanford University; Kevin Warsh, a former Fed governor; and Neel Kashkari, the president of the Minneapolis Fed who Wessel describes as a "dark horse".

Yellen said it would take a "a material deterioration" in the economy's performance for the Fed to reverse a schedule that she expects to proceed "gradually and predictably". Fed governors serve 14-year terms and Trump has come into office when several are leaving or their terms are expiring. One vacancy about to open is the seat of Vice Chairman Stanley Fischer, who is stepping down next month.

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