Last night, the U.S. Federal Reserve not only hikes interest rates by 25 basis points, it also maintained its outlook for the third hike in 2017 and unveiled its balance sheet reduction plans. The plan says that the Federal Reserve would begin to reduce its reinvestments by the end of the year.
- For Treasuries, it suggested an initial cap of $6 billion per month, which will be increased every three months and by $6 billion until it reaches $30 billion per month. For mortgage-backed securities, the introductory cap will be $4 billion per month, which will be increased every three months and by $4 billion for 12 months until it reaches $20 billion.
- Fed suggested that the maximum cap will remain in place once they get reached and that would mean a $600 billion reduction per annum. This means even if the Fed begins reduction this year, it would take 5-7 years to reduce the balance sheet to a more normal or pre-crisis level.
Despite these hawkish statements from the Fed, the financial market is not at all convinced of a third rate hike in 2017. Currently, the market is pricing the probability of a 25 basis points hike from the Fed at the December meeting, just at 44.8 percent. As of now, the next hike is priced marginally (52 percent) in March 2018.
The recent weakness in economic numbers, as well as a slowdown in inflation readings, are prompting investors to take the Fed assertions with a pinch of salt.


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