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Friday, June 21, 2024

FOMC Report, The Fed is Normalizing its Balance Sheet

Key Takeaways:

  • In the latest report, the Committee notes a “lack of further progress” in recent months, suggesting that the inflation rate has not been declining as rapidly as desired.
  • The latest report introduces a change in the pace of decline, with the monthly redemption cap on Treasury securities being reduced from $60 billion to $25 billion starting in June.

Fed Meeting

So, not a lot has changed since the last meeting. However, the Federal Reserve normalizing its balance sheet could lead to longer interest rates. Part of that consensus isn’t reflected in the current market, with the DXY down 0.22% and the S&P up nearly 1%. Continue reading for more context:

S&P 500 1-Minute Price Data After FOMC
DXY 1-Minute Price Data After FOMC

The Federal Reserve has released its latest FOMC statement on May 1, 2024, which largely echoes the sentiments expressed in the previous report from March 20, 2024. The Committee has decided to maintain the target range for the federal funds rate at 5-1/4 to 5-1/2 percent, citing continued economic expansion, strong job gains, and low unemployment rates. However, the report also highlights that inflation, although easing over the past year, remains elevated.

One difference between the two reports is the Committee’s assessment of the progress made toward its 2 percent inflation objective. In the latest report, the Committee notes a “lack of further progress” in recent months, suggesting that the inflation rate has not been declining as rapidly as desired, this was evident in the recent inflation release. This observation was absent in the previous report, indicating a growing concern among Committee members regarding the persistence of high inflation.

Normalizing the Balance Sheet

Another difference lies in the Committee’s plan to reduce its holdings of Treasury securities and agency debt and agency mortgage-backed securities. The latest report introduces a change in the pace of decline, with the monthly redemption cap on Treasury securities being reduced from $60 billion to $25 billion starting in June. The redemption cap on agency debt and agency mortgage-backed securities will remain at $35 billion, with any principal payments in excess of this cap being reinvested into Treasury securities. This adjustment was not mentioned in the March report, signaling a more gradual approach to normalizing the Federal Reserve’s balance sheet.

The Federal Reserve’s decision to normalize its balance sheet, as outlined in the latest report, could affect the economy and markets. Here’s what the Fed’s plan entails:

  1. Gradual reduction of asset holdings: The Fed aims to reduce its holdings of Treasury securities, agency debt, and agency mortgage-backed securities (MBS). By lowering the monthly redemption cap on Treasury securities from $60 billion to $25 billion, the Fed is signaling a more cautious approach to balance sheet normalization. This slower pace of reduction may help minimize potential market disruptions.
  2. Reinvestment of excess principal payments: Any principal payments from agency debt and agency MBS that exceed the $35 billion redemption cap will be reinvested into Treasury securities. This reinvestment strategy helps maintain a more stable balance sheet composition and supports the Treasury market.

Potential economic and market implications:

  1. Interest rates: As the Fed reduces its asset holdings, it effectively removes some of the monetary stimulus provided during the pandemic. This could lead to a gradual increase in long-term interest rates, which may impact borrowing costs for businesses and consumers. Higher interest rates could slow down economic growth and affect sectors sensitive to borrowing costs, such as housing and capital-intensive industries.
  2. Financial markets: The Fed’s balance sheet normalization may lead to increased volatility in financial markets, particularly in the bond market. As the Fed reduces its demand for Treasury securities and MBS, prices of these assets may fall, leading to higher yields.
  3. Dollar strength: Higher interest rates resulting from the Fed’s actions could attract foreign capital, leading to a stronger U.S. dollar. A stronger dollar could make U.S. exports less competitive and impact the profitability of multinational corporations.
  4. Inflation: The gradual reduction of the Fed’s asset holdings is an attempt to control inflation by tightening monetary conditions. If the Fed succeeds in keeping inflation in check without causing a significant economic slowdown, it could help maintain stable prices and support long-term economic growth.
Lazarus
Lazarushttps://ljlnews.com
Publisher and editor of LJLNews. I am a Stock Market enthusiast, with an interest for politics. I hope you enjoy reading the articles! Contact me at: Lazaruslucas@ljlnews.com

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