Fed Officials Continue Prep for More Rate Hikes as Balance Sheet Shrinks, ECB Hint at ‘Revisiting’ Monetary Policy…

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Every seven days the Federal Reserve issues an update of their balance sheet (which since the introduction of quantitative easing in 2009 has grown by over $3 trillion), and the latest release has shown a rapid reduction on the balance from a week ago.

For the balance sheet dated February 15th, the total came to $4.482 trillion. The balance as of February 22nd stands at $4.458 trillion, a $23.2 billion drop. $4 billion of this came from a reduction in treasury securities. According to Zero Hedge, this is the most the balance sheet has fallen since March 2012, and the lowest the balance has been overall since August 2014.

Since the announcement of the Fed’s asset reduction programme in September 2017, securities have declined by over $33 billion. All securities combined (including mortgage backed securities), the Fed has sold off $34.5 billion over a five month period.

The steepest decline in the balance sheet this week came from reserve bank credit, which the Fed describes as ‘the sum of securities held outright‘. It dropped by $23 billion in the space of a week.

Outgoing New York Fed Chairman William Dudley spoke on Friday about the Fed’s assets, and confirmed that the bank should stop reducing its balance sheet when it falls below $3 trillion. If this proves to be an accurate indication of Fed policy, that leaves a further $1.4 trillion of assets sales to come.

The initial plan was to sell off $10 billion of securities per month, an amount that would increase by a further $10 billion every quarter until the Fed were selling $50 billion of assets every thirty days.

Dudley also commented that,

The normalization process is now running in the background, essentially on autopilot, with short-term interest rates serving as the primary tool for adjusting the stance of monetary policy.

This is something that I picked up on in an update back in August 2017 when it became clear that the Fed was going to adopt a two pronged approach to ‘normalising‘ policy. Interest rate rises since the first quarter of 2017 are occurring on average every three to four months. Whilst these have gained press attention, the balance sheet reduction has thus far been a silent accompaniment. But as the Fed begin to row back further on asset holdings, the detrimental impact this will have on both bond and equity markets will start to become more pronounced.

A cursory glance will illustrate an undeniable correlation between assets purchases over the past nine years and the exponential rise in equity prices. The Fed’s loose monetary policy has coincided with record stocks. It is only logical that to withdraw that support over time will result in a downturn. The leading mechanism that has allowed for record asset valuations has been the ability of corporations to conduct stock buybacks by borrowing money at near 0% interest. As rates continue to rise, their capacity to carry on artificially inflating their own stock price will become limited as debt servicing costs grow.

So the question remains – will the Fed themselves be implicated throughout the mainstream for causing market volatility and an economic downturn, or will geopolitical stress points situated around the world begin to exacerbate and act as a distraction mechanism from the Fed’s behaviour and the tightening of international monetary policy in general? The latter is much more likely when you factor in the actions of the Trump administration, as well as the process of the UK leaving the European Union. Rising tensions in the Middle East, the spectre of North Korea and the populist / protectionist narrative promulgated by the IMF and others also remain potential triggers for an escalation.


Reuters: Bank of England’s Ramsden says weak productivity is key for rates

  • Ramsden was one of two policymakers to oppose November’s rate rise, the first in a decade. He shed little light on his latest views in his first speech since then.
  • “Overall, it’s the MPC’s view that the economy’s speed limit is likely to be around 1.5 percent,” he told businesses at an event organised by the Confederation of British Industry.
  • “With very little spare capacity in the economy, even the unusually weak actual growth of around 1.75 percent over the forecast horizon… is still sufficient to generate excess demand,” he added.

CNBC: European Central Bank could revisit its monetary policy ‘early this year,’ minutes reveal

  • ECB minutes showed that inflation, the most important economic indicator at the central bank, is picking up at a faster pace. As a result, some market participants briefly interpreted that as an indicator that monetary stimulus will come to an end earlier than previously thought.
  • “The language pertaining to the monetary policy stance could be revisited early this year as part of the regular reassessment at the forthcoming monetary policy meetings… However, it was concluded that such an adjustment was premature and not yet justified by the stronger confidence,” the bank said in the minutes.

CNBC: Global smartphone sales fall for the first time in more than a decade

  • Global smartphone sales fell by 5.6 percent in the fourth quarter of 2017 — the industry’s first decline since 2004, according to a study from research firm Gartner.
  • Chinese smartphone makers Huawei and Xiaomi were the only vendors in the top five to experience year-over-year growth in the quarter, respectively by 7.6 percent and 79 percent.
  • Samsung maintained the number one spot for global sales, growing market share from the fourth quarter of 2016, despite a 3.6 percent dip. Apple sales fell 5 percent year over year and Oppo sales fell 3.9 percent.
  • All five top vendors grew in global market share in the fourth quarter of the 2017, widening the gap between the leaders and the rest of the industry.

Reuters: Fed’s Williams sees three to four rate hikes in 2018

  • The Federal Reserve should raise U.S. interest rates three or four times this year, John Williams, president of the San Francisco Federal Reserve Bank, said on Friday, adding that the next rate hike should take place in “the near future.”
  • “A steady three to four rate increases this year is really the right path,” Williams told reporters after a Town Hall Los Angeles event.

Reuters: Fed could begin reviewing policy framework this year: Mester

  • “It may be appropriate later this year to begin an assessment of our current monetary policy framework and alternatives,” Mester said in prepared remarks to a conference of central bankers and economists in New York.
  • She noted that such reviews take time and should be thorough. Mester has previously discussed possible changes to the U.S. central bank’s inflation-targeting regime in a similar speech in January but has not endorsed any one alternative.
  • “In my view, the success of the current framework, coupled with the lack of empirical evidence on alternatives, means that the bar should be high for changing to a new framework.”

CNBC: Fed sees economy past full employment, but with only ‘moderate’ wage gains

  • “The FOMC expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong,” the report said, echoing language from prior Federal Open Market Committee meetings.
  • The Fed report offered little clarity in that regard other than to repeat language that “further gradual adjustments in the stance of monetary policy,” or “gradual increases” in the funds rate would be appropriate. Many market participants took that language, from the January FOMC meeting, to indicate a more hawkish rate stance.

Reuters: Fed’s Dudley eyes risks of betting on volatility

  • Financial products that bet on swings in equities and cryptocurrencies should be monitored to understand their risk to market stability, Federal Reserve Bank of New York President William Dudley said on Wednesday.
  • “With the stock market having a bit of a bumpy ride over the last days, there’s a question as volatility goes up, will that cause people to sell stocks,” Dudley said. “If that were the case, that could cause the stock market to be bumpy in the future.”
  • “My outlook hasn’t changed because the stock market is a bit lower than where it was a few days ago. It’s still up sharply than a year (ago),” he said.

CNBC: Fed’s Quarles pushes for gradual rate hikes, review of crisis-era bank regulations

  • “After assessing the recent data, my take is that the current shortfall in inflation from target as most likely due to transitory factors that will fade through 2018, pushing inflation back up to target,” Quarles said at the 26th International Financial Symposium sponsored by the Institute for International Monetary Affairs.
  • “At this point, we have completed the bulk of the work of postcrisis regulation,” Quarles said. “As such, now is an eminently natural and expected time to step back and assess those efforts. It is our responsibility to ensure that they are working as intended, and — given the breadth and complexity of this new body of regulation — it is inevitable that we will be able to improve them, especially with the benefit of experience and hindsight.”

Bloomberg: Wall Street Overreacts to Data But Fed Shouldn’t, Kashkari Says

  • U.S. central bankers should not allow financial markets to dictate their interest-rate decisions, Federal Reserve Bank of Minneapolis President Neel Kaskhari said, playing down the importance of recent inflation readings as just one month’s worth of data.
  • “Wall Street overreacts to everything,” Kashkari said Wednesday in a Bloomberg Television interview with Michael McKee. “They overreact on the upside, they overreact on the downside. We can’t make policy based on market blips up and down.”

CNBC: Fed’s Bullard warns that too many rate hikes this year could slow the economy too much

  • Central bankers need to be careful not to increase interest rates too quickly this year because that could slow the economy too much, St. Louis Federal Reserve President James Bullard told CNBC on Thursday.
  • “The idea that we need to go 100 basis points in 2018, that seems like a lot to me,” he said. “Everything would have to go just right. The economy would have to surprise on the upside a bunch of times during the year. I’m not sure that’s a good way to think about 2018.”
  • “One thing I’m concerned about is if [there’s] a bunch of hikes this year Fed policy will turn restrictive,” he said. “The neutral fed funds rates is pretty low.” The fed funds rate is a key short-term interest rate that banks use to lend each other money overnight.

Bloomberg: Atlanta Fed President Says ‘Things Continue to Look Up’ for U.S. Economy

  • The U.S. central bank is carefully raising interest rates against a brightening economic background that has perked up conditions for the nation’s lenders, said Federal Reserve Bank of Atlanta President Raphael Bostic.
  • After years of emergency-era monetary policy, Fed officials are now “in an increasing-rate environment, and are in the midst of a carefully-calibrated return to a more normal Fed footing, which includes the gradual reduction in our balance sheet. Banks have anticipated the increase in rates and were really excited about the prospects of higher returns, keeping in mind the need to manage interest-rate risk.”

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