US Fed hikes rates, balance sheet reduction seen in 2017
The US central bank raised its benchmark policy rate, as had been widely expected, while at the same time announcing that it would likely begin to shrink its balance sheet in 2017.
Not all analysts had expected the latter.
Following its two-day policy meeting, the Federal Open Market Committee raised the target range for the Fed funds rate by 25 basis points to between 1.0% and 1.25%.
Significantly, and possibly in reaction to weaker-than-expected CPI data for May released earlier that same day, the FOMC said it was now "monitoring inflation developments closely".
"A slowing in domestic data and reduced expectations of a 2017 fiscal loosening have clearly started to weigh on Fed thinking. Although the dots still imply another hike this year, it may now have to wait until December. Expect US treasury (UST) yields and the dollar to fall on the news, although US equities are likely to be buoyed by the more dovish outlook," said Lee Ferridge, head of multi-asset strategy for North America at State Street Global Markets.
As of 2025 BST, the yield on the benchmark 2-year US Treasury note was down by two basis points to 1.35%, versus an intra-day low of 1.28% hit following the release of the May CPI report.
The yield on the 10-year note on the other hand was off by seven basis points at 2.15%, flattening the yield curve further.
Fed still sees one more rate hike in 2017
Projections submitted by the members of the Federal Reserve board and the presidents of the regional Fed banks also showed rate-setters' expectations for inflation in 2017, on the PCE measure of prices, retreated from the 1.9% they saw in March to 1.6%.
Headline and core PCE inflation were still seen at 2.0% in 2018 and 2019.
Despite that, the Summary of Economic Projections revealed that policymakers still expected one more 25 basis point interest rate hike in 2017.
In parallel, the median forecast for the rate of unemployment during the current year came down from the 4.5% projected in March to 4.3%. Their forecasts for 2018 and 2019 decreased by a similar amount.
Meanwhile, the median projection for the Fed funds rate in 2018 was unchanged at 2.1%.
However, some observers pointed out how five new rate-setters were set to join the central bank next year, rendering the projections for next year less than reliable.
Minneapolis Fed chief Neel Kashkari dissented again, voting instead to keep the target range for the Fed funds rate unchanged.
Important not to overreact, Yellen says
When asked if the central bank had taken notice of recent weak inflation readings, Yellen said it had but added that it was "important not to over-react to a few reports, inflation data can be noisy."
Central bank provides more details on balance sheet plans
Although it did not provide a precise date for the start of its balance sheet reduction, the FOMC said it would begin to gradually roll-off a fixed amount of assets each month.
Initially, it would cap the pace of reductions for US Treasuries at $6bn a month and that for mortgage-backed securities at $4bn, for a total of $10bn.
Each would then be increased by $6bn and $4bn a month, respectively, every three months, until reaching a pace of $30bn and $20bn for each segment.
"For context, the Fed added assets at $85bn per month during QE3 and currently holds more than $4trn of assets. The upshot is that the risk of an adverse reaction in the markets should be minimal, making any pause in interest rate hikes later this year unnecessary," said Paul Ashworth at Capital Economics.