Managers' views

Fed leaves rates on hold and balance sheet reduction is coming soon

The combination of balance sheet reduction and low inflation suggests there may not be another rate hike in 2017.

03/08/2017

Keith Wade

Keith Wade

Chief Economist & Strategist

No surprises from the US Federal Reserve (Fed) with interest rates being left unchanged at the meeting on last Wednesday. The statement contained some tweaks in wording with job gains now upgraded to “solid” and inflation is noted as “running below 2%”.

Meanwhile, balance sheet reduction (the unwinding of quantitative easing) is now expected to take place “relatively soon” for which read September.

Inflation poised to head lower

Investors saw the statement as dovish which probably stems from the inflation comment which contained no reference to temporary factors depressing the rate.

Consumer price inflation is likely to head lower in coming months and, whilst the core rate should stabilise, this will make further Fed tightening more difficult.

Market expectations are for the next rate rise to come in December once balance sheet reduction is underway.

Will the balance sheet unwind cause volatility?

However, this assumes that balance sheet reduction goes smoothly. We would note though that whilst the Fed plans to start slowly, the process picks up pace at a rapid rate. From an initial $10 billion per month the rate of unwind rises to $50 billion per month in just over a year.

In the absence of any guidance from the Fed as to where the balance sheet will end up, forward-looking markets could become concerned at the impact on liquidity and yields.

Greater financial market volatility would then cause the Fed to pause the unwinding of its balance sheet and probably defer further tightening.

Further rate hike this year looks unlikely

The combination of low inflation and balance sheet unwind suggests that we will not see another rate rise this year. Further tightening will then depend on inflation picking up and some fiscal boost. We expect both, but this will probably not be apparent in the data until later in 2018.

 

Important Information
Any security(s) mentioned above is for illustrative purpose only, not a recommendation to invest or divest.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Opinions stated are matters of judgment, which may change. Information herein is believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. Exchange rate changes may cause the value of the overseas investments to rise or fall. For risks associated with investment in securities in emerging and less developed markets, please refer to the relevant offering document.
The information contained in this document is provided for information purpose only and does not constitute any solicitation and offering of investment products. Potential investors should be aware that such investments involve market risk and should be regarded as long-term investments.
Derivatives carry a high degree of risk and should only be considered by sophisticated investors.
This material, including the website, has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.