The Fed Hikes Again and Outlines Plans for Balance Sheet Normalization

Author: Mark Weinberg

June 14, 2017

The Fed Hikes Again and Outlines Plans for Balance Sheet Normalization

As highly expected, the U.S. Federal Reserve (Fed) hiked interest rates another 25 basis points today, to 1.00%-1.25%, the fourth rate hike this cycle. The day prior to the hike, markets had priced in a 98% chance that the Fed would indeed increase rates, so the news came at no surprise. The Fed is still expecting to hike rates once more this year, though the market is not convinced. The market was pricing in a 21% chance of a rate hike in September immediately following the hike, compared to 33% the day before. This is likely because of the weak retail sales and inflation data also announced, which has weighed on yields across the curve as well as on expectations for another rate hike. This is likely to change and will depend on incoming data.

In the Fed’s post-meeting statement, there were modest upgrades to its description of economic growth, and the Committee noted a further decline in unemployment, though indicated that job growth has moderated and inflation has declined. The Fed described the risks to its outlook as being “roughly balanced”.

Balance sheet normalization to occur “relatively soon”, i.e. this year

The Fed has been talking about normalizing its balance sheet more recently, and in the post-meeting statement it provided details on how it intends to shrink its balance sheet. The Fed highlighted a set of principles and a series of “caps”. Initial “caps” of US$6 billion for U.S. Treasuries and US$4 billion for Mortgage-Backed Securities (MBS) will increase at quarterly intervals until reaching US$30 billion and US$20 billion, respectively. While the Fed did not mention a start date for the balance sheet unwind, it will likely be in September or potentially December.

There were no surprises in voting positions at the meeting with all Fed voters in favour of the action except for Neel Kashkari, President of the Minneapolis Fed, who did not want to hike. Kashkari voted the same in March and is currently the most dovish voter on the Committee. He argues that the Fed should wait to hike rates, as he believes the Fed can continue to do more on its dual mandate (stabilizing prices and maximizing employment).

Summary of Economic Projections (SEP)

  • The dot plot was largely unchanged
  • The Fed continues to expect a total of three rate hikes this year (so one more in 2017) and three in 2018
  • GDP growth in 2017 was upgraded to 0.1% to 2.2%
  • The path for the unemployment rate over the next couple of years was lowered significantly to 4.3% in 2017 and 4.2% in 2018 and 2019 (in the March statement, they were 4.5% for all three years)
  • The long-run rate (their estimate of the natural rate of unemployment) was also reduced, 0.1% to 4.6%
  • Core PCE inflation for 2017 was reduced from 1.7% (1.9% in the March statement) and unchanged at 2.0% for next year
  • The federal funds rate projections were relatively stable, though median and mode for 2019 declined by 0.1% and 0.2%, respectively


Commentaries contained herein are provided as a general source of information based on information available as of June 14, 2017 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.

Written by

Mark Weinberg, ASA, ACIA

Vice President, Portfolio Specialist Group

AGF Investments Inc.

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