No surprises – US Federal Reserve increases interest rates as expected

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Key points :

Exhibit 1 : Changes in the federal funds rate since 16 September 2005

federal funds rate changes

Source: Bloomberg, BNP Paribas Investment Partners as of 16 March 2017

  •  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

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