Fed Stands Pat On Rates, Will Reduce Balance Sheet In October

Posted September 21, 2017

One is this week.

The US Federal Reserve has taken the historic decision to start unwinding its huge $4.2 trillion (£3.1 trillion) portfolio of bonds built up through its stimulus efforts following the financial crisis. Yellen, whose term ends in February, has repeatedly deflected all questions on this topic and will probably do so again.

Markets are likely to get further clarification on that front with RBA governor Philip Lowe delivering a speech entitled "The Next Chapter" in Perth later today.

The question gained added importance since the Fed's No. 2, Stanley Fischer, announced this month that he will resign on October 13.

The Fed has raised interest rates twice this year, separately in March and June.

Trump is now mulling who, if anyone, should replace Yellen in February. The only other potential choice for Fed chair Trump has mentioned is Gary Cohn, a former Goldman Sachs executive who leads the president's National Economic Council. Investors typically sell shares of utilities when interest rates rise, partly because they lose their appeal as bond proxies since investors can expect similar returns investing in bonds.

A string of weak reports on consumer prices had suppressed expectations for another rate hike this year, but that view shifted when data for August showed inflation stabilizing.

Regional banks rely more extensively on loans as a profit source than the country's largest banks, which also have significant investment banking and securities trading operations.

In her press conference, Yellen will probably avoid wading too far into a growing debate over why inflation has failed to pick up despite low unemployment.

Inflation affects prices - milk, train tickets, everything.

However, 11 of the 16 Fed officials saw the "appropriate" level for the federal funds rate to be in a range between 1.25 percent and 1.50 percent by the end of the year, increasing the likelihood of a third rate hike at the FOMC's next meeting in December. Economic growth tends to pull rates higher, and sluggish inflation tends to drag rates lower.

Some traders and investors had thought the Fed might have struck a more dovish tone given the potential economic impact of recent severe hurricanes and still sluggish inflation. But economic growth and low unemployment of 4.4 percent are saying it should.

"As long as we believe we can use the federal funds rate as a tool, that is what we intend to do".

Therefore, the Fed can feel confident that its own measures should not send yields flaring up in a disrupting way for bond markets.

The Fed said on Wednesday it would begin the years-long process of trimming its $4.5 trillion in assets, majority amassed to encourage investment and growth in the wake of the 2007-09 financial crisis and recession.

The central bank effectively lent trillions of dollars to the government to spur the economy and make it cheaper for everyone to borrow. "As you have new supply come into the market without the Fed on the other side, that's what's going to weigh on the market".

During each of the Fed's quantitative-easing cycles, yields rose when the central bank was buying and then fell after it stopped. Lowering it was "a big deal", Chris Low, chief economist at FTN Financial, wrote in a note.