US Federal Reserve begins reversal of quantitative easing

Central bank sets October start for shrinking balance sheet

Fed chair Janet Yellen said the US central bank was ready to change the interest rate outlook if needed.

Fed chair Janet Yellen said the US central bank was ready to change the interest rate outlook if needed.

 

The yen declined and the dollar extended gains against major peers as the US Federal Reserve and the Bank of Japan (BoJ) announced diverging monetary policies.

Stocks in Tokyo pared gains while they were mixed elsewhere in Asia.

The Japanese currency fell to a two-month low as Bloomberg’s dollar index rose for a second day. The US central bank set an October start for shrinking its balance sheet and maintained a forecast for another rate increase this year, while the BoJ kept its monetary stimulus unchanged.

Japan’s Topix index wiped out almost all the session’s advance. The 10-year treasury yield approached 2.3 per cent. Oil held above $50 a barrel, gold retreated and base metals tumbled.

While US policymakers left the benchmark interest rate unchanged, markets reacted to officials’ hawkish forecast for where rates will be at the end of the year as they begin a reversal of quantitative easing.

BoJ Governor Haruhiko Kuroda and his board left the target interest rates and asset purchase programme unchanged on Thursday, a decision expected by all 45 economists surveyed by Bloomberg, though one dissenting member unexpectedly emerged.

Supply concerns

A rout in iron ore continued amid mounting concerns that global supplies are set to expand while demand from China will decline. Most-active SGX AsiaClear futures in Singapore sank as much 4.3 per cent to $64.13 a metric ton, the lowest since July, with the contract headed for a third weekly loss.

In its policy statement, the Fed cited low unemployment, growth in business investment, and an economic expansion that has been moderate but durable this year as justifying its decision.

It added that the near-term risks to the economic outlook remained “roughly balanced” but said it was “closely” watching inflation.

Fed chair Janet Yellen said in a press conference after the end of the meeting that the fall in inflation this year remained a mystery, adding that the central bank was ready to change the interest rate outlook if needed.

“What we need to figure out is whether the factors that have lowered inflation are likely to prove persistent,” she said. If they do, “it would require an alteration of monetary policy,” Ms Yellen said.

While the interest rate outlook for next year remained largely unchanged in the Fed’s latest projections, with three rises envisaged in 2018, the US central bank did slow the pace of anticipated monetary tightening expected thereafter.

It forecasts only two increases in 2019 and one in 2020. It also lowered again its estimated long-term “neutral” interest rate from 3 per cent to 2.75 per cent, reflecting concerns about overall economic vitality.

The Federal Reserve has firmly signalled that a December rate rise is still on the table,” said Luke Bartholomew, of Aberdeen Standard Investments Investment Strategist in London.

“Clearly the Fed still believes that lower unemployment will eventually translate into a pick-up in inflation, but if inflation continues to undershoot it is hard to see the Fed following through on a hike,” he said.

The Federal Reserve will resume rate hikes in December and raise borrowing costs three more times in 2018, a Reuters poll found on Wednesday.

Treasury bonds

The Fed, as expected, also said it would begin in October to reduce its approximately $4.2 trillion in holdings of US treasury bonds and mortgage-backed securities by initially cutting up to $10 billion each month from the amount of maturing securities it reinvests.

That action will start a gradual reversal of the three rounds of quantitative easing, or bond buying, the Fed pursued between 2008 and 2014 to stimulate economic growth after the 2007-2009 financial crisis and recession.

The limit on reinvestment is scheduled to increase by $10 billion every three months to a maximum of $50 billion per month until the central bank’s overall balance sheet falls by perhaps $1 trillion or more in the coming years.

Ms Yellen said it would take a “a material deterioration” in the economy’s performance for the Fed to reverse a schedule that she expects to proceed “gradually and predictably”.

The policy statement and accompanying projections showed the Fed still in the middle of a balancing act between an economic recovery that has kept US unemployment low and is gaining steam globally and a recent worrying drop in US inflation.

Three of the hawkish policymakers appeared to move their expected policy rate down to account for only one more hike by the end of 2017, leaving a core 11 clustered around a likely December increase. The Fed has raised rates twice this year. – (Agencies)