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Sam Fleming in Washington SEPTEMBER 20, 2017 https://www./content/caf45d6a-9e28-11e7-8cd4-932067fbf946 The Federal Reserve will throw its crisis-era stimulus programme into reverse from next month and stick with plans for further rate rises in a mark of confidence that stagnant inflation is set to bounce back. The US central bank, chaired by Janet Yellen, held interest rates on Wednesday but said it would consider a further rate rise this year. It starts paring back its multitrillion-dollar balance sheet in October. While acknowledging the damage inflicted by recent hurricanes, most policymakers stuck with forecasts for another rate rise in 2017, most likely in December, as well as three further increases in 2018. The dollar index, which measures the US currency against a basket of its peers, swung from a loss to be up 0.7 per cent after the statement and Ms Yellen’s press conference. The yield on the 10-year Treasury also climbed, from about 2.24 per cent immediately preceding the announcement to 2.27 per cent soon afterwards, while the policy-sensitive two-year yield jumped from 1.38 per cent to 1.43 per cent. In a unanimous decision, the Fed said it would start normalising its balance sheet next month. The move by the world’s most influential central bank to start paring back its asset holdings is a pivotal moment as policymakers around the world gingerly retreat from the support operations they put in place during the worst financial meltdown of modern times. “The basic message here is US economic performance has been good; the labour market has strengthened substantially,” Ms Yellen said during her press conference. “The American people should feel the steps we have taken to normalise monetary policy are ones we feel are well justified, given the very substantial progress we have seen in the economy.” Recommended Listen: Fed can’t feed the dollar beast Analysis: Yellen refuses to be derailed by low-inflation mystery Markets: Dollar biggest beneficiary as Fed sticks with tightening plan The Federal Reserve’s statement — annotated The Fed more than quadrupled the size of its balance sheet to $4.5tn by purchasing Treasuries and mortgage-backed securities under Ben Bernanke, its former chairman. The European Central Bank has recently indicated that it will wind down its asset purchase scheme as it responds to firmer growth in the euro area, while the Bank of England has suggested it could lift short-term rates this year in response to higher inflation risks. Signs of a global upswing have helped spur the Fed to lift rates twice this year and prepare to pull back its quantitative easing programme, as falling unemployment and steady growth reduce the need for emergency levels of monetary support. Still, the central bank’s policy committee remains divided over the urgency of further tightening, given a string of poor inflation figures. The consumer price index jumped in August, but this followed five months of weak readings and is unlikely to dispel all the worries among Fed officials about soggy price growth. In a sign of concerns about weak inflation, the median Fed policymaker now does not expect core inflation to hit the 2 per cent target until 2019, compared with 2018 previously. Ms Yellen said the committee believed the recovery was on a “strong track” and that slack in the labour market had largely disappeared. A tighter labour market tended gradually to push up wage and price growth, she said. However, Ms Yellen added that the shortfalls in inflation this year had been something of a mystery and it was not easy to point to a set of factors that explained why it had been so low. The Fed would determine whether the factors that had lowered inflation were persistent or merely transitory based on the incoming data, she said. In a signal of their caution over the economy’s longer-term potential, officials brought down their median expectation for official rates in the long term, cutting it from 3 per cent to 2.8 per cent. That chimes with a longstanding view among many investors that the Fed will not be able to lift rates very far; going into Wednesday’s announcement, markets saw only a 50-50 chance of two rate increases by the end of next year.  In a statement accompanying its decision, the Fed gave a broadly optimistic take on the current economic picture, saying business investment had picked up even with inflation running below target. The Fed acknowledged that recent hurricanes had inflicted “severe hardship” but insisted that experience suggested they would not materially affect the course of the national economy. Any boost to inflation from the storms was likely to be fleeting. At present, the US central bank reinvests the payments it receives on the portfolio of government bonds and mortgage-backed securities (MBS) that it amassed during the financial crisis, keeping its overall holdings steady. When the rundown of the balance sheet starts, the Fed will gradually phase out these reinvestments. The Fed’s plan involves setting a steadily increasing set of caps: payments will only be reinvested to the extent they exceed the caps. The caps will initially be set at $6bn per month for Treasuries and $4bn for agency MBS. They will be steadily lifted in three-month intervals until they peak at $30bn for Treasuries and $20bn for MBS in about a year’s time. The initial cap will first be applied to holdings of Treasuries on October 31, while an announcement will be made on MBS holdings on October 13. In accompanying forecasts, policymakers once again had to reduce their estimate for inflation in the near term following the recent disappointments. They cut their estimate for core inflation at the end of 2017 to 1.5 per cent from 1.7 per cent in June, with inflation excluding food and energy not returning to target until 2019. Unemployment is now seen as dropping to 4.1 per cent next year and in 2019, compared with 4.2 per cent previously. The longer-run unemployment rate remained at 4.6 per cent. At 2.4 per cent, the estimate for growth this year was somewhat stronger than June’s outlook of 2.2 per cent. The median forecast for the midpoint of the Fed’s interest rate target range was left at 1.4 per cent in 2017, unchanged from its June outlook. The prediction was centred at 2.1 per cent in 2018, also unchanged. The 2019 prediction was 2.7 per cent compared with 2.9 per cent earlier, and the new 2020 expectation was 2.9 per cent. The backstory Highlights from the FT’s coverage of the Federal Reserve and its decision to unwind its $4.5tn balance sheet GDP has strongest quarter since 2015 Fed ready to unwind crisis-era stimulus FT View: The fractious politics of debt End of QE challenges Fed and Treasury How the Fed plans to unwind massive market stimulus The reduction in the long-run forecast to 2.8 per cent suggests policymakers have become even less optimistic about the growth and inflation outlook further down the road, meaning rates will need to be lifted less than previously anticipated. Markets have appeared largely unconcerned by the prospect of the Fed’s retreat from money-printing; two increases in short-term rates this year coupled with signals of a reduced balance sheet have done little to tighten financial conditions in the US thus far. But major changes on the board of the Fed — where Donald Trump has the possibility of installing as many as five new governors — could yet overturn the ultra-predictable strategy that Ms Yellen is setting in train. In addition, the outlook for bond yields could be swung by the possibility of fiscal loosening by the Republican-led Congress. In the Senate, lawmakers are edging towards a budget resolution that could pave the way for tax cuts amounting to as much as $1.5tn over 10 years. |
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