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All eyes on the Fed

By David Morrison  |  30/01/2019 15:29

The US Federal Reserve releases its monetary policy statement this evening. Following this, Fed Chair Jerome Powell will hold a press conference. Will he give any clues about future balance sheet reduction?

The US Federal Reserve is currently holding its first monetary policy meeting of 2019 and will release its statement at 19:00 GMT tonight. This is not a big quarterly meeting, so we won’t get an update on the FOMC’s Summary of Economic Projections as one was released last month. However, this is still an important gathering as, in addition to the Fed’s rate decision and accompanying statement, Fed Chairman Jerome Powell will be holding a press conference, as he will after every monetary policy meeting from now on. Mr Powell is likely to be quizzed over his dovish pivot which manifested itself over the fourth quarter of 2018 and which he clarified at the beginning of this year during a roundtable discussion with two of his predecessors, Janet Yellen and Ben Bernanke.

Change in tone

Back in early October Mr Powell said that, with an upper bound of 2.25%, the fed funds rate was “a long way from neutral”. He was, along with his colleagues at the US central bank, also praising the US economy’s strength and resilience, with unemployment at record lows and inflation picking up. A little more than six weeks later he declared that the Fed was “very close to neutral”. This change in tone did little to halt a slide in global equities which saw the S&P 500 lose around 20% of its value between October and Christmas Eve. In fact, despite Mr Powell’s dovish shift, the Fed raised its key interest rate by 25 basis points at its December meeting, although the FOMC shifted down its 2019 forecast for rate hikes to 50 basis points from 75 basis points. Markets aren’t pricing in any further hikes over the coming year.

Balance sheet

But that still leaves the question of the Fed’s balance sheet reduction and this is what observers will be focused on tonight. Since October 2017 the Fed has reduced its balance sheet from around $4.5 trillion to just under $4 trillion. Previously, the central bank has insisted that this wind-down was pretty much a side issue when compared to rate hikes and would take place on ‘autopilot’ at an approximate rate of $40 billion per month. However, by raising rates and reducing its balance sheet simultaneously, the Fed has been criticised for running a monetary experiment with two variables, making it impossible to measure the effects of either action. On top of this, we’ve had a collapse in the oil price while Chinese and European economic data releases point to a serious global economic slowdown. This has led to speculation that not only would the Fed hold off from further rate hikes at least until the summer, but that it may pause, or even halt, its balance sheet reduction programme.

Equities bounce back

But while the Fed may indicate that it is in no rush to raise rates further, it may not come up with the goods when it comes to talking about balance sheet reduction. For a start, markets have stabilised since Christmas with the S&P 500 having recovered over 50% of its losses since the October peak. The Fed can take much of the credit for this. It could argue that by holding off on further rate hikes but continuing with its balance sheet reduction, it can properly assess the effects on markets of a change in a single variable. On top of this, the Fed must be wary of being too dovish and turning negative on the US economy for fear of triggering another sell-off on raised recession concerns. So, it would seem reasonable that Mr Powell and his colleagues will try to steer a middle course. Unfortunately, this may prove to be a disappointment for investors who are desperate for all developed-world central banks to continue with monetary stimulus, thereby giving the green light to load up on stocks again.
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