Invesco Canada blog

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Brian Schneider | June 14, 2017

Full steam ahead: Fed hawkish, hikes rates

The U.S. Federal Open Market Committee (Fed) hiked its key interest rate by 0.25% today, to a target range of 1% – 1.25%. While the hike was fully expected by the market, recent inflation prints, such today’s May CPI falling by -0.1%, had left an expectation this would be a dovish hike. As it turns out, the Fed announcement was hawkish as it formally announced the details of their balance sheet normalization.

The statement from the Fed indicated that “the labor market has continued to strengthen and economic activity has been rising moderately”. Any concerns about job growth moderating recently appeared to be offset by the continued decline in the unemployment rate. Other positives noted by the Fed were the increase in household spending and business fixed investment. The Fed acknowledged recent weakness in inflation, but appeared to look through that weakness by stating it expects inflation to “stabilize around their 2 percent objective over the medium term”.

The Fed summary of economic projections changed only modestly. Their 2017 GDP estimate was revised +0.1% to 2.2% and core personal consumption expenditure (PCE) inflation measure was revised down to 1.7% in 2017, but remained unchanged at 2.0% for 2018 and 2019. The 2017 dots remained unchanged for the Fed Funds rate and it maintained the earlier outlook for one more rate hike this year.

We believe that hike will occur in December, assuming inflation stabilizes.

The Fed noted that when it begins the process of reducing the balance sheet, it will reinvest payments that exceed gradually rising caps. The initial cap on Treasury securities will be $6 billion per month and will increase in $6 billion increments every three months over 12 months until the cap reaches $30 billion per month. For principal payments on agency debt and mortgage securities, the cap will be $4 billion per month initially and will increase in $4 billion increments every three months over 12 months until it reaches $20 billion per month.

The Fed also expects that the caps will stay in place once they reach their maximums, allowing the balance sheet to decline in a gradual and predictable manner. There was no announcement on when the balance sheet reduction will begin, but it appears likely that it will start at the meeting in September.

At Invesco Fixed Income, we remain reasonably positive on global growth expectations and today’s announcement does not change that outlook, although the risks of a Fed policy error may be growing. At the moment, we believe the environment should remain relatively positive for stocks and bonds in general.

The next Fed meeting is on July 26. We expect no significant announcement to be made at that meeting.

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