Fed: how it plans to reduce its massive $4.5 trillion balance sheet

Analysts at UOB Group explained that the Fed raised the fed funds rate by 25bps, as was widely expected, with Neel Kashkari being the sole dissenter, preferring no change in policy at this meeting.

Key Quotes:

"As far as the dot plot was concerned, the median participant continues to expect one further rate hike in 2017 (four participants see two further hikes and four see no further hikes). This is followed by a projection of three further hikes in 2018 and three more hikes in 2019 (essentially unchanged from the March projection, although the projected fed funds rate at the end of 2019 was lowered to 2.9% - just below the unchanged projected long-term rate of 3.0%).

The latest economic projections contain a slight downward revision to core PCE inflation to 1.7% this year, but the projection for 2018 and 2019 was unchanged at 2.0%. Forecasts for GDP growth were little changed but forecasts for the unemployment rate were lowered across the horizon, with the assumed long-term unemployment rate lowered a tenth to 4.6%.

The accompanying statement contained a number of minor changes – the description of the economy was slightly more upbeat, and it was acknowledged that inflation had declined somewhat and in the near-term would likely remain below 2%. The Fed also provided more details on how it plans to reduce its massive $4.5 trillion balance sheet.

The Fed expects that for Treasuries the cap of allowed maturities will be set at $6bn per month initially, increasing in steps of $6bn at three-month intervals over 12 months until it reaches $30bn per month. For agency debt and MBS the initial cap will be $4bn per month, increasing in steps of $4bn at three-month intervals over 12 months until it reaches $20bn per month.

Once at their maximum run-off rate, the Fed expects that “holdings will continue to decline in a gradual and predictable manner until the Committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively”."

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