Reading the Tone of the Fed at the June Meeting

Xavier Trudeau
Juin 15, 2017

At a meeting of its Federal Open Market Committee, the U.S. Federal Reserve, or Central Bank, approved a quarter-point increase in its benchmark target, moving the rate from 0.91% to 1.25%, despite inflation running below the bank's targeted 2%.

The Fed said it would initially reduce its holdings by $10 billion a month for three months, divided 60-40 between Treasuries and mortgage bonds. Those figures would rise in increments over a year until they reached $30 billion a month in Treasurys and $20 billion in mortgage bonds.

In addition to raising short-term rates, the FOMC also seeks to normalize the size of its balance sheet, which has ballooned to well over $4 trillion.

United States bond yields climbed as high as 2.6% in December as markets grew optimistic that the Trump administration's proposals for tax reforms and infrastructure spending would provide a boost to the economy and raise inflation.

"It just looks like the Fed is sticking to their story and the market remains highly sceptical that the Fed is going to be able to deliver just based upon underlying data".

That said, as the Fed continues to raise rates in the coming year or two, that should eventually cause mortgage rates to go up.

The central bank kept the federal funds rate at zero from December 2008 through December 2015.

With this latest increase, the federal funds rate, the interest rate at which banks and other financial institutions borrow from one another, is at 1 to 1.25 percent. But that's where the Fed falls back on the theory that an economy that is employing all of its resources is susceptible to rising prices. Fed policy makers also signaled they were likely to raise rates once more this year, which helped lift yields on two-year notes, the most sensitive to Fed rate policy expectations, from their lows of the day.

The Fed kept forecast for economic growth this year of 2.2 per cent, up slightly from its March forecast, with growth of 2.1 per cent in 2018 and 1.9 per cent in 2019.

USA 10-year yields were last at 2.134 percent, below their US close of 2.138 percent on Thursday, when they fell as low as 2.103 percent, their lowest since November 10.

The most immediately apparent effects of the rate hike will be seen in consumer interest rates that are tied to a baseline interest rate, such as the prime rate. Unemployment has already reached a 16-year low of 4.3%.

The policymakers now expect their favored measure of inflation to come in at 1.6 percent this year, down from the 1.9 percent they expected in March and below their 2 percent target. Only one committee member (Neel Kashkari) dissented from the vote.

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