Economist's Insights

FOMC Holds Rates Steady, Hints at Upcoming Balance Sheet Adjustment

Jul 26, 2017

The FOMC voted unanimously to leave its overnight target range unchanged at 1.00 to 1.25% and continues to expect the data to justify their gradual tightening pace.  The Committee’s assessment of the labor market and household spending was upgraded fractionally.  The Statement notes that job gains “have been solid,” an improvement from job gains “have moderated.”  The Statement also notes that household spending has “continued to expand,” another slight upgrade from the June Statement.

Inflation Running below Target but Not a Concern for Now

As it relates to inflation, the Statement acknowledged the weaker data.  The June Statement noted that inflation had “declined recently…running somewhat below 2 percent.”  The July Statement stated that inflation is now “running below 2 percent.”  However, the Statement reflects no more concern about the below-target inflation, continuing to say that it is expected “to stabilize around the Committee’s 2 percent objective over the medium term.”

Balance Sheet Normalization Expected to Begin “Relatively Soon”

The Committee continues to expect to begin its balance sheet normalization program sooner than later.  The June Statement pointed to the program being implemented “this year” but the July Statement tweaked the timing to occurring “relatively soon.”  “Relatively soon” has been a key phrase for Fed officials over the past year hinting at pending action.  As such, this wordsmithing implies a possible announcement at the FOMC’s next meeting in September.

Bottom Line: All told, the FOMC appears to expect to begin its balance sheet adjustment program, or at least announce the timing of its commencement, at their September meeting.  While they acknowledge the weaker inflation data, it has not raised enough concern to alter their communications at this point.  Fedspeak will be key over the coming weeks as investors attempt to decipher individual views on inflation, the balance sheet adjustment program, and future rate hikes.  The communications will begin Friday with Kashkari and continue next week with Mester and Williams.

Risks to the FOMC’s Expected Path: There remain several near-term risks to the FOMC’s expected path for gradually tightening policy.  Most notably, inflation has proven to be weaker-than-expected and more broad-based than the transitory “idiosyncratic” factors cited by the FOMC earlier this year.  If inflation does not show some traction, the doves may regain their conviction that slower is better.  There are also policy matters which could become factors affecting the FOMC’s decisions.  The debt ceiling needs to be raised and the CBO has estimated that Treasury can use “extraordinary measures” to continue funding the government through mid-October.  If the debt ceiling is not raised by the September FOMC meeting, depending on how the debate is progressing, it could potentially give the Fed reason to pause for fear of market disruptions.  Moreover, there is great uncertainty at present over policy reforms coming out of Washington.  With healthcare and tax reform hanging in the balance, how Washington functions going forward could also alter the FOMC’s plans.