3 things to watch for from the Federal Reserve today

Ivan Schwartz
September 23, 2017

Wednesday's move to unwind its massive bond holdings is yet another sign of the Fed's confidence in the economy. The Fed stopped buying new bonds in 2014 but kept its balance sheet high by reinvesting the proceeds of maturing bonds.

Under the plan the Fed announced, it will start to allow a slight $10 billion in holdings to roll off the balance sheet each month - $6 billion in Treasurys and $4 billion in mortgage bonds.

Still, the Fed said in a statement that prices for gasoline and other items might temporarily spike because of the damage caused by Hurricanes Harvey, Irma and Maria.

Despite the lagging inflation, a majority of officials see room for another rise in the key interest rate target set by the Federal Reserve before the end of the year, according to the economic forecast released after Wednesday's meeting.

Stocks are inching mostly lower on Wall Street after the Federal Reserve said it would start reducing its huge bond portfolio next month and was still on track to raise interest rates later this year. Investors will look for clues on Wednesday as to what the ultimate goal for the size of the Fed's portfolio might be. That figure would inch up by US$10 billion each quarter until it reaches US$50 billion in monthly reductions in October 2018.

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However, the Fed lowered its rate forecast for 2019 to 2.8% from 3%. The risk exists that investors could become spooked by the rising number of bonds being transferred back into private hands. If that were to happen, long-term rates might surge undesirably high, which could weigh on the economy.

The Fed did lower its projection for its so-called neutral rate. The Fed views the job market as strengthening, but it notes that inflation is running below its 2 percent annual target.

Some analysts believe economic damage from two devastating hurricanes over the past month, and possibly more on the way, could postpone a hike projected for later this year until mid-2018. The further the interest rates are from the zero lower bound, the bigger will the room be for balance sheet normalization. Today Fed Chair Janet Yellen said the innovative program was a success. In fact, Yellen acknowledged that the Fed didn't fully understand the reasons for low inflation. Before the crisis, the Fed held less than $900 billion in assets, and most analysts expect the Fed to maintain a significantly larger balance sheet going forward - both because the financial system has grown and because the Fed has expanded its role in maintaining the system.

The Fed must decide how soon to resume raising interest rates.

Hence, for the moment at least the widely-tracked "dot plot" projections indicated that another hike in 2017 was still a possibility - albeit not a foregone conclusion. Yet the Fed's decision to begin winding down one of its most controversial policies of the crisis era, which attracted sharp criticism from congressional conservatives and economic purists over the last decade, amounted to a bold bet on the US economy's prospects. She will certainly be asked. "This means that 4 of 7 seats in the Board of Governors - including the two most important members of the FOMC - will be appointed by the Trump administration, which could have an impact on the course that the Fed will take in the coming years".

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