Economics: Fed raises rates, unveils balance sheet cuts in sign of confidence.

The Federal Reserve raised interest rates on Wednesday for the second time in three months and said it would begin cutting its holdings of bonds and other securities this year, signalling its confidence in a growing US economy and strengthening job market.

In lifting its benchmark lending rate by a quarter percentage point to a target range of 1.00% to 1.25% and forecasting one more hike this year, the Fed seemed to largely brush off a recent run of mixed economic data.

The US central bank’s rate-setting committee said the economy had continued to strengthen, job gains remained solid and indicated it viewed a recent softness in inflation as largely transitory.

The Fed also gave a first clear outline on its plan to reduce its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession.

It expects to begin the normalisation of its balance sheet this year, gradually ramping up the pace. The plan, which would feature halting reinvestments of ever-larger amounts of maturing securities, did not specify the overall size of the reduction.

The initial cap for the reduction of the Fed’s Treasuries holdings will be set at $6bn per month, increasing by $6bn increments every three months over a 12-month period until it reaches $30bn per month.
For agency debt and mortgage-backed securities, the cap will be $4bn per month initially, rising by $4bn at quarterly intervals over a year until it reaches $20bn per month.

The Fed announcing an update to its reinvestment principles leaves September open for the start of balance sheet run-off, and the fact that the central bank hasn’t slowed its projected path of rate-hikes suggests it can do both balance sheet reduction and rate-increases at the same time. However, we don’t expect the next rate move until December.

Alan McQuaid
Economist