Key points :
- As widely anticipated the Federal Open Markets Committee (FOMC) raised its target range for the federal funds rate by 25 basis points on 14-15/03/17. The target range for the federal funds rate is now 0.75 – 1%. This is the third increase in this cycle of rate hikes which began in December 2015 (see Exhibit 1 below).
Exhibit 1 : Changes in the federal funds rate since 16 September 2005
Source: Bloomberg, BNP Paribas Investment Partners as of 16 March 2017
- This was the first of the quarterly (March, June, September, December) FOMC meetings in 2017 associated with publication of a Summary of Economic Projections (SEP). Members of the FOMC did not take this opportunity to signal a more aggressive path for rate hikes in 2017 – on the contrary, the macroeconomic and policy rate projections were more accommodative than markets had expected. There was no change to the FOMC’s broad outlook since the prior projection round in December 2016. The median projection – or ‘dot plot’ – for three rates increases in 2017 remains unchanged.
- Since the start of the year there has been some speculation about how the Federal Reserve may go about ‘normalising’ its balance sheet. Currently the Federal Reserve holds assets totalling around USD 4.5 trn, including USD 2.5 trn of US Treasuries and USD 1.76 trn of mortgage-backed-securities (MBS). The size of these holdings means financial markets are sensitive to any notion of change in the Fed’s policy of managing these assets. In her press briefing after the FOMC meeting on 15/03/17 Chair Yellen mentioned that the Committee discussed an eventual change to the reinvestment policy “as a matter of prudent planning”, but that no decisions had been reached and that discussions will continue in the future. The house view at BNP Paribas Investment Partners is that the FOMC will not pre-commit to a specific level of the federal funds rate at which balance sheet runoff will begin. Instead they will likely prefer to keep their options open by seeing how financial conditions and progress towards policy goals evolve before announcing any change in balance sheet policy. On this basis we would reckon with a gradual phasing out of the current reinvestment policy at the December 2017 meeting, with implementation to begin in January of 2018.
- As the increase in interest rates had been widely flagged by members of the Federal Reserve in recent weeks, the reaction in financial markets after the Fed’s announcement yesterday was limited. Yields of US Treasuries fell as did the US dollar index – perhaps reflecting relief in markets that expectations, in some quarters, of a more aggressive path for interest rate increases had not been fufilled.
Written on 16 March 2017