Fed Backstops Risk

To watchers of the US Federal Reserve, the biggest surprise lately was an announcement to end balance sheet reduction in September. This should keep assets near USD3.5 trillion, significantly higher than previously indicated. The Fed is also reducing the cap on US treasuries allowed to mature each month from USD30 billion to USD215 billion in May. Anxieties about a scarcity of reserves in the banking system are the driver. Regulatory shifts since the financial crisis demand banks to maintain safe capital that can be used in case of an economic shock. This has increased the demand for “safe” US T-bills. Interest rates may have peaked: this should put a floor on US equities.

The US domestic economy has failed to generate inflation above the Fed’s 2% target. The risk of a pre-emptive hike would be to push the USD higher and further slow economic activity. The Fed has downgraded its economic growth estimate. GDP growth was lowered for 2019 to 2.10% from a previous estimate of 2.3%. Unemployment is forecast to rise to 3.7% in 2019 against 3.5% at the December 2018 meeting. The Fed’s median for inflation is set at 1.8% in 2019 and 1.9% in 2020 and 2021.


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