Fed Minutes Draw Mixed Reaction from Financial Markets

Danny Woods
July 6, 2017

The Federal Reserve plans to reduce their bloated balance sheet but failed to provide a specific timeline to begin the process, the minutes of the June Federal Open Market Committee showed.

The strengthening job market left a lot of them comfortable with raising a key short-term rate last month.

The market isn't pricing in any chance of a hike at the next meeting on July 26 but beyond that it gets intriguing. One of the goals of gradually unwinding the balance sheet would be to not disrupt broader economic growth despite the possibility of rising long-term rates. The Australian dollar was last trading at $0.7600, not far from a low of $0.7591 hit just after the Reserve Bank of Australia (RBA) ended its Tuesday meeting with rates unchanged at a record low 1.50 percent.

"We continue to expect another rate hike in September followed by the announcement of the balance sheet run-off in December", Harm Bandholz, chief U.S. economist at UniCredit Bank in NY, wrote in a note to clients.

The lone dissenter to the decision was Minneapolis Fed President Neel Kashkari, who argued in a subsequent op-ed that inflation doesn't show signs of picking up soon. The Fed's preferred measure of inflation is tracking at 1.4 percent over the past 12 months.

Fed officials also expressed not much concern that low inflation would persist.

The path of inflation going forward appears to be a source of tension inside the Fed. The market is expecting the bank to approach that issue conservatively, pausing its rate hikes while it sells off some of those securities.

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"The Fed has raised rates three times in the last seven months, the markets haven't squeaked".

There have been discussions over the Bank of England raising United Kingdom interest rates in the coming months, with BoE governor, Mark Carney's hawkish remarks last week nearly subliminally positioning markets for a surprise.

Paradoxically, policymakers are toying with the idea of tweaking up the inflation target for the industrialised economies though most central banks have consistently fallen short of the current 2% rate in the last 10 years. Investors saw a almost 20 percent chance of another rate hike in September, and a 60 percent chance of another rate hike or two by December.

Since that meeting, final GDP figures for the first quarter showed economic growth was better than expected. A few Fed officials noted that stock prices were high relative to traditional methods of valuation.

Some members of the Federal Open Market Committee (FOMC), which sets the benchmark United States interest rate, also expressed concern that Wall Street stocks were overvalued and that years of loose monetary policy could create risks for financial stability.

"Several" policy makers were in favor of starting the reduction of its $4.5 trillion balance sheet within a "couple of months".

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