Treasuries rally, yield curve steepens on Fed balance sheet plan

Federal Reserve Lowers Key Rate By Three Quarters Of A Point

The Federal Reserve is well on the way to policy normalisation

Members of the Federal Open Market Committee (FOMC) are divided on how President Donald Trump's fiscal stimulus package will affect the USA economy, minutes from a Federal Reserve meeting showed Wednesday.

Yet the Fed has yet to begin significantly reducing the massive amount of Treasurys and mortgage-backed securities it purchased during the financial crisis to try to spur lending and keep interest rates low.

Brian Battle, director of trading at Performance Trust Capital Partners in Chicago also said the late afternoon selloff was related to the Fed minutes and the comment that the Fed sees a change to its reinvestment policy as likely to be appropriate.

Capital Economics' chief United States economist Paul Ashworth said upside risks in the minutes now outweighed downside ones, suggesting there could be a fourth rate rise this year. "Participants generally preferred to phase out or cease reinvestments of both Treasury securities and agency mortgage-backed securities", said the minutes.

What they all agreed on was that shrinking the balance sheet should be gradual and predictable and almost all said that any altering of the policy "should be communicated.well in advance of an actual change".

The Fed could reduce its balance sheet during its March meeting, including the possibility of ending its policy of reinvesting principal payments.

As the newly-released minutes indicated, the Fed could very soon begin selling those assets off, triggering a speedier rise in general interest rates, and, as a result of the rise in the cost of borrowing, a potential market panic and fears of economic slowdown.

The Fed has been keeping the level of its balance sheet steady at $4.5 trillion, compared with less than $1 trillion before the financial crisis.

On inflation, the minutes showed that some Fed officials anxious that if unemployment, now at a low of 4.7 percent, fell even further, it could pose a "significant upside risk" of higher inflation.

The minutes said that because of the "substantial uncertainties" about the outlines of the program that might eventually emerge from Congress, about half the Fed officials had included no assumptions about Trump's efforts in their economic forecasts.

There was less agreement over the issues of inflation and Trump's economic plans. ". some participants and their business contacts saw downside risks to labor force and economic growth from possible changes to other government policies, such as those affecting immigration and trade". The Fed's two goals are to achieve maximum employment and moderate inflation.

While markets have been pricing-in two more interest rate hikes this year, a reduction of the Fed's bond holdings also would act as a tightening of monetary policy. Unemployment is now below the Fed's 4.8 percent goal, while inflation has remained below the Fed's 2 percent inflation goal for several years.

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