Fed Keeps it on the QT

Much to no one's surprise, the Federal Reserve held off on raising short-term interest rates; keeping the fed funds rate in a range of 1.00-1.25%, in a unanimous vote. Although they did not say anything explicit, there were a few niblets on which to chew in the statement accompanying the meeting. It highlighted that a period of weak inflation continues—which Fed chair Janet Yellen has suggested is somewhat due to temporary factors—and that overall inflation remains below the Fed’s 2% target. Inflation is one of the Fed's dual mandates—the other being employment, the commentary around which was upgraded in the statement.

The statement retained the prior language that it expects to continue to raise rates at a "gradual" pace; assuming economic data is in line with forecasts. To date, the Fed has raised rates four times; yet over that same period, financial conditions have actually loosened. This is why the Fed feels it can continue to tighten policy in the face of lower inflation. Easier financial conditions, despite higher rates, have supported economic growth as well as the stock market.

The addition of the words "relatively soon" to the statement further supports the September meeting as the likely start point to balance sheet shrinkage. We believe that if the Fed does indeed begin quantitative tightening (QT) in September, they will likely hold off on an additional rate hike at that meeting. We do believe another rate hike later in the year is in the cards.

As a reminder, the Fed's balance sheet now contains over $4.5 trillion in Treasury and mortgage-backed securities (MBS); of which $3.7 trillion was added during the Fed’s three rounds of quantitative easing (QE).

As already detailed before today's meeting, for payments of principal that the Fed receives from maturing Treasury securities, the Federal Open Market Committee (FOMC) anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month. For payments of principal that the Fed receives from its agency debt and MBS, the FOMC anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

Next up is the Jackson Hole annual conference, at which Yellen will speak, which could provide an opportunity to further steer the consensus around QT's timing. There is a September timing risk however, given that we could be in the midst of a debt ceiling stand-off, so stay tuned.

(0717-7YG4)