Fed leaves Rates Unchanged but Kicks off Balance Sheet Reduction

Commenting on today’s interest rate announcement from the Federal Reserve, Tom Stevenson, investment director for personal investing at Fidelity International, comments:

“The US Federal Reserve has, as expected, left interest rates unchanged at between 1 and 1.25%. With inflation in the US subdued and Hurricanes Harvey and Irma expected to impact the US economy over the short term, no-one will be surprised the Fed sat on its hands.

“In addition, also as expected, the Fed has fleshed out its plans for reining in the size of its balance sheet. This has ballooned since the financial crisis on the back of America’s massive quantitative easing stimulus programme. The balance sheet has expanded to $4.5trn since the financial crisis. The plan is to start reducing it from next month and to progressively accelerate the rate at which bonds are returned to the public market. The Fed hopes that by telegraphing its $1trn to $2trn taper, it can avoid unsettling bond and equity markets.

“However, the real focus is on how the markets will react over the longer term to policy normalisation. The trajectory of rate hikes is indicated by the so-called dot plots, which signal rate-setters’ views of future rate rises. Today’s chart continues to suggest that the Fed will press ahead with one more quarter-point interest rate hike by the end of the year and three further quarter point hikes in 2018. This will provide some support for the dollar, which has weakened in 2017 on expectations for lower for longer US interest rates.

“If the Fed does pull the trigger on another hike in December, it will add to the upward pressure on bond yields (and so downward pressure on bond prices). However, structural issues – namely still high global debt, an ageing global population and rising inequality – should help to keep a lid on yields and so support bond prices. In addition, US financials such as banks also stand to benefit from higher rates, as they will see a boost to their lending margins.”