As widely expected, the Fed raised rates between 1 and 1.25%, citing growth in U.S. employment but also noting a weak inflation rate. Kim Parlee speaks with Beata Caranci, Chief Economist, TD Bank Group, about what was surprising in the statement and how the outlook has changed.
So Beata, the Fed has come out pretty much as expected. They've increased rates by 25 basis points. They say they're going to be shrinking the balance sheet this year, their $4 and 1/2 trillion balance sheet. And they're saying they're maintaining the forecast for one more hike. Any of that catch your attention? Or was this all expected?
All as expected, and the market reaction demonstrates that. There wasn't a large move on bond yields or in the US dollar today. So very much expected. They left ambiguous the timing of when they're going to normalize the balance sheet, but they laid out a little bit more of a clear plan. And it was in the sense of being very slow and cautious approach. That was reinforced today.
Yeah, in terms of the taking liquidity out, I heard someone-- quantitative tightening, instead of quantitative easing. But I think before when they talked about it, they didn't have a monthly cap. But this time, they said they would. Again, is that just to kind of ensure the markets that this is the rate at which it's going to go?
Yeah. So much like you do with interest rates, where you try to telegraph your moves so that there's not a market surprise or a sharp adjustment in bond yields, they're going to do the same on this front. And so now they're giving you a sense of the speed of adjustment they're going to do and the time length.
It's about five quarters before they hit what they would call a normalization pattern in terms of their max level that they're going to be running off thereafter. So very gradual, very stepwise, gradual moves up until that five quarter period. Again, it's not intended to surprise the markets. It's meant to run in the background, not be something that overtakes the primary policy tool, which is the rise in interest rates, which is their main focus.
What about the fact that, I mean, some people will say-- and I think you and I were chatting before-- that even some of the economic data coming out of the States, you know, the first few bits before this came out, was slowing down. The inflation numbers were looking a little weak.
Yeah. So this is a little bit of a challenge on the Fed side going forward, because you know, they have a dual mandate. And one is a stabilization of the unemployment rate, as well as on the inflation side. It's these two push and pull forces. And employment and unemployment rates have been working in their favor. The unemployment rate is very low. Job growth has been pretty steady.
Inflation has gone in the opposite direction to expectations. So it's actually trended down in the last few months. And their belief is that these are largely related to transitory factors, one-offs, such as a drop in wireless costs, physician or, more likely, prescription costs having come down. And therefore, these are not really material in terms of a broadening out of weakness.
They're very focused areas, which will allow them to continue to raise rates. If it proves otherwise in the next couple of months, that it's actually a broader weakening, then that gives them reason to take a pause. So while they still put in an expectation of one more hike this year, you really do need inflation to kind of tick up for that to materialize.
To verify that.
Yeah, I think so.
Let me ask you this last question in terms of what's coming. Again, this all seems very predictable, manageable, like the market likes to see. But if you think about the exogenous things-- the Trump administration, potential tax cuts, fiscal stimulus, could we see new committee members, or we're going to see new committee members next year-- with all that, how does that change things?
The Fed's always been very data dependent. And Janet Yellen reinforced that repeatedly in a Q&A session that there is no pre-set course for monetary policy. They react to the information as it becomes available. So the shifting of the Fed members-- there's several committee members, in addition to Janet Yellen's position, is up.
An important one, yeah.
And the vice chair as well. So a lot of shifts happening there. That would probably be less material, because whoever's put in place is going to have to be reactive to the data. So I would say that at the end of the day, it's whatever's happening in the economy. If there's fiscal stimulus that comes through that boosts growth projections or boosts inflation projections, they will react to that information.
Beata, thanks very much.