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Fed holds rates steady, expects portfolio cuts 'relatively soon'

Published 07/26/2017, 04:06 PM
Updated 07/26/2017, 04:06 PM
© Reuters. The Federal Reserve Building in Washington

© Reuters. The Federal Reserve Building in Washington

By Jason Lange and Lindsay Dunsmuir

WASHINGTON (Reuters) - The Federal Reserve kept interest rates unchanged on Wednesday and said it expected to start winding down its massive holdings of bonds "relatively soon" in a sign of confidence in the U.S. economy.

The Fed kept its benchmark lending rate in a target range of 1.00 percent to 1.25 percent, as expected, and said it was on track to continue the slow path of monetary tightening that has lifted rates by a percentage point since 2015.

In a statement following a two-day policy meeting, the U.S. central bank's rate-setting committee indicated the economy was growing moderately and job gains had been solid.

It also noted that both overall inflation and a measure of underlying price gains had declined - trends which have worried some policymakers - but that it expected the economy to continue strengthening.

"The committee expects to begin implementing its balance sheet normalization program relatively soon," the Fed said, adding that it would follow a plan outlined in June to trim its holdings of U.S. Treasury bonds and mortgage-backed securities.

U.S. stock prices rose following the release of the policy statement while yields on U.S. government debt fell. The dollar dropped against a basket of currencies.

After pushing rates nearly to zero to fight the 2007-2009 financial crisis and recession, the Fed pumped over $3 trillion into the economy in a bond-buying spree to further reduce rates. Its balance sheet has grown to $4.5 trillion.

The statement cemented expectations the Fed will announce at its next policy meeting in September the start of its balance sheet reduction plan, marking the end of a controversial tool that drew criticism from Republican lawmakers in Congress.

"The Fed all but told the market the balance sheet run-off will start in September," said Brian Jacobsen, an investment strategist at Wells Fargo (NYSE:WFC) Funds Management in Menomonee Falls, Wisconsin.

INFLATION JITTERS

Torsten Slok, an economist at Deutsche Bank (DE:DBKGn), said the Fed appeared keen to begin balance sheet reduction given the uncertainty over whether President Donald Trump will nominate Fed Chair Janet Yellen for another four-year term.

Trump told the Wall Street Journal this week that Yellen, whose current term expires in February, was among several candidates he would consider to lead the central bank.

While Fed researchers have concluded that bond buying only modestly boosted the economy, Yellen has said the central bank could turn to asset purchases again if the economy fell into a deep rut.

Steady job creation in the economy has pushed the U.S. unemployment rate to 4.3 percent, near a 16-year low.

The Fed had previously signaled it would begin to trim its balance sheet this year.

At the same time, a slowdown in inflation has caused jitters among some Fed officials who are concerned inflation has been below the central bank's 2 percent target for five years.

The Fed's preferred measure of underlying inflation dropped to 1.4 percent in May from 1.8 percent in February. The Fed had described inflation as being "somewhat" below target in its policy statement in June, but on Wednesday it simply stated that it was below 2 percent.

© Reuters. The Federal Reserve Building in Washington

"That, I think, is a signal that it's a slightly more cautious tone," said Omer Esiner, an analyst at Commonwealth FX in Washington.

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