U.S. Fed holds rate, to shrink balance sheet in October

     The U.S. central bank maintained  its benchmark federal funds rate at 1 – 1.25 percent, as expected, but will begin shrinking its massive $4.47 trillion balance sheet in October as it takes another small step toward tighter monetary policy.
      The Federal Reserve, which has raised its rate twice this year by a total of 50 basis points, also maintained its forecast for raising the fed funds rate by another 25 points this year and raised its forecast for economic growth this year.
      After slashing interest rates to essentially zero and purchasing government bonds and housing-related debt in the wake of the global financial crises, the Fed in December 2015 began raising its rate and will now turn its attention to normalizing its balance sheet that ballooned from less than $900 billion pre-2008 as it sought to hold down long-term interest rates to stimulate economic growth.
      The Fed’s decision to begin whittling down its holdings of securities in October was largely expected, illustrating the Fed’s policy of making sure it doesn’t surprise financial markets.
      Back in June the Fed first laid out its principles and plans for gradually decreasing the reinvestments of principal payments from its securities. At that point it said the process would begin “this year” and then followed up in July when it said it would begin “relatively soon,” giving financial  markets plenty of time to digest the implications for the critical Treasury market.
       At first the Fed will roll over principal payments from Treasuries that exceed $6 billion and reinvest payments from agency debt and mortgage-backed securities that exceed $4 billion.
       This cap on how much the Fed reinvests will then rise in three-month intervals over the next 12 months until it reaches $30 billion a month for Treasuries and $20 billion for housing securities.
       The gradual tightening of the Fed’s monetary policy comes as the U.S. economy continues to improve, with the Fed describing economic activity as “rising moderately” as household spending expands and business investment picks up, resulting in “solid” job gains.
      The impact of recent hurricanes – Harvey, Irma and Maria – is expected to affect economic activity in the near term but based on past experience the Fed doesn’t expect any lasting damage.
       Inflation may be boosted temporarily from higher gasoline prices but apart from that, the Fed still expects inflation to remain below 2 percent in the near term before stabilizes around this level – its target level – in the medium term.
       As in July, the Fed said near-term risks to its economic outlook were roughly balanced and it was monitoring inflation closely.
        The Fed’s policy-making arm, the Federal Open Market Committee (FOMC) was once again unanimous in its decision.
       In an update to its economic projections, the Fed expects its key interest rate to rise to 1.4 percent this year, implying one more rate hike, and then rise to 2.1 percent in 2018, implying three hikes.
      In 2019 the fed funds rate is seen rising to 2.7 percent, down from 2.9 percent forecast in June as the longer-run rate was lowered to 2.8 percent from 3.0 percent. In 2020 the rate is seen at 2.9 percent.
       The U.S. economy is seen expanding by 2.4 percent this year, up from the June forecast of 2.2 percent but then easing to 2.1 percent next year, unchanged from June. In 2019 the economy is seen expanding by 2.0 percent up from 1.9 percent and then by 1.8 percent in 2020, which is also the longer-run growth rate.
      The Fed’s preferred inflation gauge, personal consumption expenditure, is seen averaging 1.6 percent this year, unchanged from June, and then 1.9 percent next year, down from 2.0 percent,. In 2019 and 2010 inflation is seen at 2.0 percent.
      The U.S. headline inflation rate rose to 1.9 percent in August from 1.7 percent in July while the annual growth rate in the second quarter rose to 2.2 percent from 2.0 percent in the first quarter.

      The Board of Governors of the Federal Reserve System issued the following statements:
     
     

• The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate paid on required and excess reserve balances at 1.25 percent.
• As part of its policy decision, the Federal Open Market Committee voted to authorize and direct the Open Market Desk at the Federal Reserve Bank of New York, until instructed otherwise, to execute transactions in the System Open Market Account in accordance with the following domestic policy directive:
  

  “Effective September 21, 2017, the Federal Open Market Committee directs the Desk to undertake open market operations as necessary to maintain the federal funds rate in a target range of 1 to 1-1/4 percent, including overnight reverse repurchase operations (and reverse repurchase operations with maturities of more than one day when necessary to accommodate weekend, holiday, or similar trading conventions) at an offering rate of 1.00 percent, in amounts limited only by the value of Treasury securities held outright in the System Open Market Account that are available for such operations and by a per-counterparty limit of $30 billion per day.

  The Committee directs the Desk to continue rolling over at auction Treasury securities maturing during September, and to continue reinvesting in agency mortgage-backed securities the principal payments received through September from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities.

  Effective in October 2017, the Committee directs the Desk to roll over at auction the amount of principal payments from the Federal Reserve’s holdings of Treasury securities maturing during each calendar month that exceeds $6 billion, and to reinvest in agency mortgage-backed securities the amount of principal payments from the Federal Reserve’s holdings of agency debt and agency mortgage-backed securities received during each calendar month that exceeds $4 billion. Small deviations from these amounts for operational reasons are acceptable.

  The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions.”

• In a related action, the Board of Governors of the Federal Reserve System voted unanimously to approve the establishment of the primary credit rate at the existing level of 1.75 percent.