Fed raises key rate and unveils plan to reduce bond holdings

Erica Roy
June 15, 2017

US stock indices initially rose, but then gave up those gains after the Federal Reserve raised its key interest rate by a quarter of a percentage point and unveiled plans to begin shrinking its $4.5 billion balance sheet starting this year. In 3.31pm trading in NY, the Dow Jones Industrial Average eked out a 0.05 percent gain.

Since the last Fed bond buy in late 2014, the S&P 500 has gained 10.2 percent on an annual basis, said Allen Bond, co-portfolio manager of the Jensen Quality Growth Fund (JENSX).

Probable decision of the US Federal Reserve System (Fed) to raise the key rate won't have a big effect on the Azerbaijani manat's rate, John Hardy, Saxo Bank's head of foreign exchange strategy, told Trend June 13.

United States stocks rose slightly after the Fed announcement while the dollar reversed some of its earlier losses though bond yields moved little.

Despite the increase - the fourth since December 2015 - interest rates remain near historic lows, but the move will mean higher borrowing costs for consumers. Before the release of Wednesday's statement, traders in future markets placed only a 37% probability of one more rate increase this year, according to CME Group, and an 18% probability of a second quarter-point increase by mid-2018. The consumer price index, excluding food and energy, rose.1% from April when the median estimate called for a.2% gain.

More important was what the U.S. central had to say about its plans to rein in its bloated balance sheet, which has ballooned to $4.5 trillion since the financial crisis as the Fed has bought government and mortgage-backed bonds to underpin the American economy. Interestingly, two commonly used short-term Treasury yield proxies appear to disagree for the first time during this rate hike cycle [Figure 1]. And auto loan rates won't likely change much. Lael Brainard, a Fed governor, has suggested that balance sheet reduction could start after the Fed funds rate range gets midway towards policymakers' median projection for the long-run value of the Fed funds rate, which is now 3 per cent.

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At the end of its two-day meeting, the Federal Open Market Committee announced its decision to lift the target range for its fed funds rate by a quarter percentage point to between 1 percent and 1.25 percent.

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They increased their projections for economic growth this year to 2.2 percent from the 2.1 percent they forecast in March. The Fed said this process is expected to begin later this year as long as the economy "evolves broadly as anticipated". Its holdings now stand at roughly $4.5 trillion, including $2.5 trillion of Treasuries and $1.8 trillion of mortgage-backed securities. Unemployment has already reached a 16-year low of 4.3%.

But anticipation surrounds the possibility that the Fed could signal policy shifts in a statement it will issue, in updated economic forecasts and in a news conference with Yellen.

CURRENCY: The euro was flat at $1.12 while the dollar rose 0.2 percent to 110.31 yen. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

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