Today, in a widely anticipated press conference, the Fed announced its plan to pare its $4.5 trillion portfolio of bonds acquired since the 2008 crisis and maintained the possibility of a rate rise in December (as well as three further rises in 2018). Janet Yellen noted that she still believed the recent dip in inflation figures (currently running below 2%) to be transitory, as opposed to reflecting deeper, structural changes, restating that “we believe the recovery is on a strong track”. This caused a rally in the dollar as well as financial stocks, while the yield on the 10 year treasury climbed from 2.24% to 2.27%. The decision to start normalizing the balance sheet was unanimous and sends a strong message of support and stability that is likely to shore up markets and investor confidence.
This comes despite the uncertainty that may be circulating following the US President’s firmly “America First” rhetoric before the UN this week, and fiery response to North Korean provocations, as well as a relentless hurricane season in the Caribbean and the Gulf, which today wiped out all power to Puerto Rico. The Fed did acknowledge that the recent hurricanes could give a temporary boost to inflation, but it seemed prepared to look through that in its assessment of the baseline level.
It is also likely that the balance sheet downsizing is likely to be highly predictable and to occur as maturing debt (Treasuries and MBS) run off – as opposed to outright selling. As such it is deliberately designed not to “shock” markets and is in keeping with the current carefully telegraphed approach to all actions.