Fed Prepares for the Big Unwind

Flash Points:

  • Fed balance sheet unwinding to be gradually unwounded with initial reduction caps
  • Inflation picks up in August, breaking 5-month streak of sluggish data
  • Market positioning still seen tilting towards dovish stance with only rate hike priced-in until 2018
  • Leadership uncertainty at the Fed prompts policy continuity risk

All Eyes on Fed September Policy Meeting

The US Federal Reserve is scheduled to meet for its upcoming policy meeting on September 19 – 20 to discuss the current economic climate and decide on further monetary policy adjustments.

Although there is no expectation for a change in interest rates during this month’s policy meeting, it still holds particular importance to markets.

Central bank watchers are eagerly anticipating the Fed to finally pull the trigger and begin the unwinding process of its US $4.5 trillion balance sheet – a culmination of its massive bond-buying programme which it accumulated following the 2008 GFC.

The Fed has previously said in a recent communique that it will start the unwinding of its balance sheet “relatively soon”.

Most observers have interpreted this statement to mean that an announcement will be forthcoming at its upcoming September policy-meeting or latest by this year-end. The unwinding exercise is then slated to begin in the month subsequent to the announcement.

Impact to Markets – Don’t Hold Your Breath

Whilst some observers are rightfully anxious over this perceived squeezed liquidity and a possible end of the easy-money era which kept the economy afloat since the 2008 GFC – markets aren’t necessarily holding their breath or bracing for any large corrections.

The unwinding exercise will be gradual in nature, in line with the Fed’s mandate to placate markets and ensure that the economy continues to chug along at a moderate pace of growth.

The initial reduction caps of its balance sheet will be gradually unwounded by US $6 billion per month for US Treasuries (UST) and US $4 billion per month for mortgage-backed securities (MBS). Subsequently, it then follows a step-up schedule to increase the cap by US $6 billion for UST and US $4 billion for MBS by every 3 months respectively.

Eventually, after a year from inception, the Fed is then expected to increase to maximum reductions caps to US $30 billion per month for USTs, and US $20 billion per month for MBS.

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