The Federal Reserve made no changes to interest rates today and made almost no changes to the text of its statement. However, the wording changes it did make strongly support our view the Fed will announce the start of balance sheet reductions at the end of its next meeting on September 20.
First, the Fed qualified its reference to maintaining its current policy of rolling over principal payments by saying this was the policy only for the "time being."
Second, at the last meeting in June, the Fed said renormalization would start "this year." Now it says "relatively soon," the same language Fed Chief Yellen used at the press conference (but not the Fed's official statement) back in June.
Third, back in June the Fed said it "currently" expected to start renormalizing the balance sheet. That left the Fed wiggle room to change its own expectation, as if it anticipated the possibility of making a change to its timing. Now, by removing "currently," the Fed is essentially saying the likelihood of changing its mind is much lower.
Put it all together and it looks like an announcement about renormalization is very likely to happen at the next meeting. Moreover, there were no dissents at all from today's statement, unlike in June, when Minneapolis President Neel Kashkari made a dovish dissent.
We expect the Fed's September announcement about renormalization to follow the path suggested in June. For the first three months (presumably, October – December) the Fed will reduce its balance sheet by $10 billion per month ($6 billion in Treasury securities, $4 billion in mortgage-related securities). Then, every three months, the amount of monthly balance sheet reduction will rise by $10 billion (with the same 60/40 proportion between Treasury securities and mortgage-related securities). That escalation will continue until the Fed is cutting its balance sheet by $50 billion per month (presumably in the last quarter of 2018).
Meanwhile, the Fed softened language surrounding inflation expectations, but made it clear they still anticipate inflation moving towards their 2% inflation target over the medium term. Given the continued improvements in the labor market and consistent – if modest - inflation, we still anticipate the Fed will raise rates once more in 2017. That may change as markets react to the balance sheet normalization process and additional economic data, but, unlike many in the market, we place the odds of a December rate hike at well over 50%.
While others fret about renormalization and rising rates damaging the economy or financial markets, investors should remain bullish. Look for faster economic growth and a continuation of the bull market in equities in the years ahead.
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist
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