Fed raises key rate and unveils plan to reduce bond holdings

The Federal Reserve raised interest rates on Wednesday for the second time in three months, citing continued United States economic growth and job market strength, and announced it would begin cutting its holdings of bonds and other securities this year.

The Fed raised interest rates 25 bps to 1.00-1.25%, as expected. The Fed's favourite price gauge was 1.7 per cent higher in April than a year ago, down from 1.9 per cent in March and 2.1 per cent in February.

On Wednesday, the Federal Open Market Committee Raised Rates to 1.00-1.25%, which was a 25bp hike and said they anticipate another hike before the year is over. Its policy-setting committee also indicated the economy has been expanding moderately, and that it viewed a recent softness in inflation as transitory, according to a statement following a two-day meeting.

Crude oil prices slumped almost 4 percent to their lowest close in seven months on Wednesday, hit by an unexpected large build in gasoline inventories and an worldwide outlook that suggests a big increase in supply in the coming year. ​ After rising for three consecutive days, U.S. West Texas Intermediate crude futures fell $1.73, or 3.7 percent, to settle at $44.73 per barrel, its lowest close since November 14.

"The committee now expects to begin implementing a balance sheet normalisation programme this year, provided that the economy evolves broadly as anticipated", the Fed said in its statement.

"We expect mortgage rates will remain above the previous years through the summer as the Federal Reserve continues to tighten monetary policy", says Ruben Gonzalez, economist at Keller Williams.

They forecast USA economic growth of 2.2 percent in 2017, an increase from the previous projection in March.

A retreat in inflation over the past two months has caused jitters among some Fed officials who fear that the shortfall, if sustained, could alter the pace of future rate hikes. Five Fed officials projected raising rates three or more times this year. Before Yellen began speaking, they had seen June 2018 as the earliest meeting for a next rate hike.

It said the rate increase and accompanying comments bolster our view that the fed funds rate is likely to normalise at 3.5% by 2020, and USA 10-year bond yields will rise back above 4%.

In addition, the Fed provided more detail on how it will unwind its $4.5 trillion balance sheet, or portfolio of bonds that includes Treasurys, mortgage-backed securities and government agency debt. The Fed began buying the bonds after the Great Recession to try to depress long-term loan rates.

And the most important pillar of the economy - the job market - remains solid if slowing, with employment at a 16-year-low of 4.3 percent - even below the level the Fed associates with full employment. Those figures would rise in increments over a year until they reached $30 billion a month in Treasurys and $20 billion in mortgage bonds. The unemployment rate, at 4.3%, is at its lowest level since 2001. By then, the Fed's forecast would put its key policy rate at 3 percent. The report, Yellen said, reflects some priorities that the Fed has emphasized in crafting regulations and administering capital and liquidity requirements, along with the stress testing and "living wills" process.

  • Zachary Reyes