(Reuters) – The Federal Reserve said on Wednesday it would keep interest rates unchanged and announced plans to slow the pace of its balance sheet reduction after warning against the shift for much of the start of the year.
The Fed said that starting June 1, it is reducing the cap on Treasury bonds that mature and cannot be replaced to $25 billion from the current cap of up to $60 billion per month. The Fed left the cap on how much mortgage-backed securities it can remove from its books at $35 billion per month and will reinvest any excess MBS principal payments in Treasury bonds.
The announcements came at the end of the Federal Reserve’s two-day Federal Open Market Committee meeting. It was widely expected that the key interest rate would remain at 5.25% to 5.50%, but it was signaled that the central bank was still leaning towards an eventual reduction in borrowing costs. It was a warning sign for recent disappointing inflation numbers and suggested a possible stall in the move toward greater balance in the economy.
MARKET RESPONSE:
STOCKS: The S&P 500 was able to reduce a slight loss to -0.07%.
BONDS: The yield on the benchmark 10-year U.S. bond fell slightly to 4.632%. Two-year bond yield fell to 4.996%
FOREX: The dollar index extended its loss to -0.21%, while the euro gained slightly with a gain of 0.22%
COMMENTS:
JEFFREY ROACH, CHIEF ECONOMIST, LPL FINANCIAL, CHARLOTTE, NC
“On the surface it’s definitely a little combative. But the fact that the Fed is extending the tapering a little further tells me that it wants to start easing conditions. You don’t want to add to the tightness. This shouldn’t be too much of a surprise for markets other than the taper changes. Essentially, in the short term, there could be some downward pressure on rates as the short end of the curve falls off a bit. Therefore, at this point we are still reliant on future inflation readings.”
MONA MAHAJAN, SENIOR INVESTMENT STRATEGIST AT EDWARD JONES, NEW YORK
“In general, we expected Powell and the Fed to be a little more hawkish, but some of that was already priced in as markets are only expecting one rate cut this year anyway.”
“In recent weeks, Powell and the Fed have taken a more hawkish stance given the positive inflation surprises we saw in the first three months of the year. The markets had adjusted accordingly.”
“The question remains whether they would wait in the future or whether they would consider an alternative way to actually raise rates. “That’s not our base case and is probably more of a tail risk than anything else.”
“They are starting to slow the pace of reducing their balance sheets.”
“The Fed had talked about this at the last meeting, so it was expected to come in the second half of the year. It’s probably a little too early. “It’s a signal that they’re starting to think about easing monetary policy, and that’s it.” The first step in that direction could be seen as a positive sign that puts at least a little less pressure on Treasury markets.”
MICHAEL ROSEN, CHIEF INVESTMENT OFFICER, ANGELES INVESTMENT ADVISORS, SANTA MONICA, CA
“The decision to keep rates stable was no surprise, but the aggressive tapering reduction that reduced the Fed’s balance sheet was a small surprise and slightly bullish for bonds as it means the Fed will allow less supply. “Taking bonds off the balance sheet out of the market.”
“But the Fed still has the persistent problem of inflation, which is well above target and showing signs of rising. This means that any easing of restrictions is still a long way off. Furthermore, the complete lack of fiscal discipline means the Treasury will have to take on trillions of dollars in debt this year, an enormous amount that will limit any bond gains.”
“With the Fed remaining on hold and the yield curve still inverted, we remain short duration and look forward to capturing the higher yields at the short end of the curve.”
JOHN VELIS, FX AND MACRO STRATEGIST, BNY MELLON, NEW YORK
“The lack of a change in forward guidance (which still suggests that the Fed sees the next move as a cut – dependent on inflation) was slightly dovish, and I’m not sure about the newly inserted language about lack of progress in inflation is enough to compensate for this. I’m surprised the Fed has maintained its commentary on possible future rate cuts.
“The balance sheet reduction is a little faster than expected ($25 billion versus the expected $30 billion), but since bonds have only declined by an average of $51 billion, the move is halving to $25 billion . US dollars the actual outflow. ”
MATT STUCKY, CHIEF EQUITY PORTFOLIO MANAGER, NORTHWESTERN MUTUAL WEALTH MANAGEMENT COMPANY, MILWAUKEE, WISCONSIN
“I don’t think there are many surprises in the statement. If there is a slightly dovish trend compared to expectations, it is the fact that the cap on the transfer of government bonds was a little tighter than the markets had expected.”
“The statement reiterates that the Fed still sees 2% as its inflation target…if (inflation) does not meet their expectations, they will not cut (rates) any time soon.”
SAM STOVALL, CHIEF INVESTMENT STRATEGIST, CFRA RESEARCH, NEW YORK
“They didn’t really expect that there would be any shocking statement coming out of the statement. This thing is being closely scrutinized and if there is going to be any reaction up or down today, then it will be this,” a result of the responses during the press conference.
“We’ll have employment data at the end of the week, so that’s something. But in my opinion there are several things that will slow the market. One is the persistence of inflation, the actual inflation readings, the concern that we are seeing a slowdown in economic growth based on the latest GDP numbers combined with PMI data, and consumer confidence is weaker than expected.”
BRIAN JACOBSEN, CHIEF ECONOMIST, ANNEX WEALTH MANAGEMENT, MENOMONEE FALLS, WISCONSIN “The Fed has finally realized that its balance sheet contraction is doing more harm than good. It did not help reduce inflation. It just increased volatility in the bond market. Financial stability concerns must dominate their thinking. The Fed must use the right tool for the right job: inflation rates and its balance sheet for financial stability.”
MICHELE RANERI, VICE PRESIDENT OF US RESEARCH AND CONSULTING, TRANSUNION, CHICAGO (via email)
“The new GDP report is a likely indicator that the “longer-term higher” interest rates previously announced by the Fed are not going away anytime soon. U.S. consumers should be prepared to expect relatively high interest rates on a range of credit products for some time to come, with potential rate cuts likely postponed until later in 2024.”
“Ultimately, this could result in the mortgage and auto markets remaining relatively sluggish as consumers continue to wait for interest rates to fall. If interest rates only start to fall later in 2024, this could actually mean that many homebuyers may wait until later 2024 or even into 2025.”
MATTHAIS SCHEIBER, GLOBAL HEAD OF PORTFOLIO MANAGEMENT, SYSTEMATIC EDGE TEAM, ALLSPRING GLOBAL INVESTMENTS, LONDON (e-mail to Reuters) “As expected, the Federal Open Market Committee decided to keep its key interest rate, the federal funds rate, unchanged at 5.25- 5.50% to be left. We expect the Federal Reserve (Fed) will not cut interest rates until it sees a weakening in prices and labor market data – probably not until the fall. The base effects of falling energy prices in 2023 will now disappear. Service prices, the biggest driver of current inflation, have stabilized over the past three months after falling significantly last year. The good news is that the breadth of inflation (how many goods and services increase at the same time) continues to decline. However, inflation persistence (how persistent inflation will be) has accelerated again. As a result, the short-term interest rate market has readjusted and is now more pessimistic about rate cuts: Compared to the Fed’s estimate of three rate cuts in 2024, the market – which had originally expected five rate cuts in 2024 – now expects just one.
“Our base case is that the Fed sticks to its course until inflation and growth data weaken enough to justify less restrictive monetary policy. These conditions should be met by the end of the third quarter of this year.”
“We continue to favor bonds that benefit from weaker growth and inflation – particularly internationally.” We also continue to like stocks. Despite a short-term struggle, earnings and forecasts have remained robust and any easing of perceived looser monetary policy would likely support share prices in the medium term.”
(Compiled by the Global Finance & Markets Breaking News team)