Fed switching focus to balance sheet reduction - AmpGFX

The Fed has risen rates to a point where it is shifting focus to balance sheet reduction, explains Greg Gibbs, Analyst at Amplifying Global FX Capital. 

Key Quotes

“Yellen has argued that the aim is for balance sheet reduction to be conducted in the background, and the fed-funds rate will be the main policy instrument.  Nevertheless, balance sheet reduction is a form of removing policy accommodation, and it will tend to delay and slow rate hikes.  This is a point made by several FOMC members in the Fed minutes and very explicitly by Fed member Lael Brainard in a speech on Tuesday.”

“The minutes said:

“Several participants indicated that the reduction in policy accommodation arising from the commencement of balance sheet normalization was one basis for believing that, if economic conditions evolved broadly as anticipated, the target range for the federal funds rate would follow a less steep path than it otherwise would. However, some other participants suggested that they did not see the balance sheet normalization program as a factor likely to figure heavily in decisions about the target range for the federal funds rate. A few of these participants judged that the degree of additional policy firming that would result from the balance sheet normalization program was modest.”

“A “few participants” that supported the rate hike in June, “were less comfortable with the degree of additional policy tightening through the end of 2018 implied by the June SEP median federal funds rate projections.”  This suggests that they were biased towards delaying hikes as the QE wind-down proceeded.”

“Canada, of course, has no need for balance sheet reduction and is more focused on rates policy.  It is now in the mode of normalizing rates, and if the Fed hits pause on rates as its balance sheet reduction gets moving, the CAD may strengthen further.”

“The CAD has already risen significantly, and the market will be reluctant to keep buying for the time being, but the focus must turn to other countries that may also need to normalize policy via conventional rate hikes.  Australia and New Zealand are possible candidates.”