The Fed addressed the issues we are concerned with, in quite a dovish tone, at the January meeting. As widely anticipated, the Fed funds rate stayed unchanged at 2.25-2.5%. The members removed the forward guidance of gradual interest rate increases. They called for patience on further normalization, as inflation pressured has eased and uncertainties in the global economic and financial developments have intensified. Despite growing worries over the global developments, the Fed remained upbeat about the US economy. This suggests that the next move in the monetary policy should still be a hike. The Fed added that they are prepared to adjust the details of the balance sheet normalization in response to the change in economic developments. The market views that as implication that the balance sheet reduction plan could end earlier than previous anticipated, and/ or the size of reduction would be trimmed. Indeed, the Fed has not revealed how much it has intended to shrink the balance sheet. As the reduction plan has been in progress more than a year, it is prudent to assess the situation and communicate with the market its intended size of the balance sheet.

Slight Downgrade on Economic Assessment

As we have anticipated, the Fed slightly downgraded its economic assessment. At the accompanying statement, it noted that “economic activity has been rising at a solid rate”, compared to previous description of “strong”. However, the Fed reiterated the view of “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2% objective”. On inflation, the latest statement added that “market- based measures of inflation compensation have moved lower in recent months”. Yet, it retained previous view that indicators of “longer- term inflation expectations are little changed”.

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Calling for Patience in Future Rate Adjustment

The close-watched forward guidance has been removed. In the past, the Fed used to indicate that there would be “some further gradual increases in” the Fed funds rate and suggest that “risks to the economic outlook are roughly balanced”. This time, the Fed noted that it would be “patient as it determines what future adjustments” to the policy rate, due to “global economic and financial developments and muted inflation pressures”. Meanwhile, it removed the risk bias, implying that the members themselves do not have conviction on the risks to the economic outlook.

Balance Sheet Normalization

The Fed released the “Statement Regarding Monetary Policy Implementation and Balance Sheet Normalization”, together with the policy statement. The key message is that the Committee is “prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments”. Also, the Committee would be “prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate”. At the press conference, Chair Jerome Powell suggested that the members would “in coming meetings” discuss the balance sheet plan. The market views that as implication that the balance sheet reduction plan could end earlier than previous anticipated, and/ or the size of reduction would be trimmed. We are rather neutral on this matter. Indeed, the Fed has not revealed how much it has intended to shrink the balance sheet despite the fact that the reduction plan has been in progress more than a year. It is prudent to assess the situation and communicate with the market its intended size of the balance sheet.

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