Stockholm (Ekonamik) – On Wednesday, February 27, the Chairman of the Federal Reserve System of the USA presented the Federal Reserve’s semiannual Monetary Policy Report to Congress. His comments were in line with recent expectations. There were no hints of an acceleration in rate hikes or in balance sheet adjustments, such as the ones that disrupted markets at the end of 2018.
Following the increase of the Fed Funds rate on 19 December 2018, markets reacted strongly to the suggestion that further rate hikes and quantitative tightening might be planned for 2019. By December 24th the SP500 had fallen 7.7%, following the decision. Wary of the consequences, the Fed reversed course and started hinting at a slower pace of interest rate hikes and balance sheet decrease. In Fed-speak, policy rates went from being perceived to be “just below” the neutral level on November 28, to “in the range of the Committee’s estimates of neutral” by January 30.
The testimony to Congress echoed this more accommodative stance. “In January, with inflation pressures muted, the FOMC determined that the cumulative effects of these developments, along with ongoing government policy uncertainty, warranted taking a patient approach with regard to future policy changes. Going forward, our policy decisions will continue to be data dependent and will take into account new information as economic conditions and the outlook evolve,” stated the Fed Chairman on future interest rates decisions.
Regarding the size of the Fed’s balance sheet, the Fed Chairman noted that “we have also continued to gradually shrink the size of our balance sheet by reducing our holdings of Treasury and agency securities. The Federal Reserve’s total assets declined about $310 billion since the middle of last year and currently stand at close to $4.0 trillion. Relative to their peak level in 2014, banks’ reserve balances with the Federal Reserve have declined by around $1.2 trillion, a drop of more than 40 percent”.
“Forecasters peg the endpoint for the Fed’s balance sheet at somewhere in the $3.5 trillion range. At the current clip of $50 billion in net bond maturities per month, the Fed could well be done its remaining bond sales in under a year. More realistically, given a likely desire to smoothly decelerate, the process could take slightly longer,” according to Eric Lascelles, Chief Economist at RBC Global Asset Management.
“ING’s house view believes the current Fed pause could resolve itself in one last rate hike – perhaps in 3Q19. However, the bar to that hike looks quite high and the Fed pause could easily turn into something longer – such as the twelve month pause in Fed rates seen between summer 2006 and summer 2007. The Fed Fund futures strip certainly prices that story, with the next full 25 basis point Fed move (a cut) not priced until summer 2021,” commented Chris Turner Global Head of Strategy and Head of EMEA and LATAM Research at ING.
Perhaps the most interesting part of the Chairman’s testimony to Congress was his answer to a question from Sen. Jon Tester, Democrat from Montana, about the repercussions of a failed interest payment by the US government, because of the debt ceiling. “It’s beyond even consideration. The idea that the U.S. would not honour all of its obligations and pay them when due is something that can’t even be considered,” Chairman Powell replied according to CNBC.
Picture from Board of Governors of the Federal Reserve System.