As the FOMC meeting looms later this month, markets are fully prepped for a rate hike despite some underwhelming releases from the USA economy.
The Fed also gave a first clear outline on its plan to reduce its $4.2 trillion portfolio of Treasury bonds and mortgage-backed securities, most of which were purchased in the wake of the 2007-2009 financial crisis and recession. We are not there yet, but the next few weeks will be very interesting to see if long bonds rise because investors are fearing inflation and more rate hikes to curb it, or if long bonds break below the 2016 yield curve trough in a sign that investors are more anxious about the outlook for growth and fear that long bonds are portending a recession.
The Fed said the initial cap for Treasuries would be set at $6 billion per month initially and increase by $6 billion increments every three months over a 12-month period until it reached $30 billion per month in reductions to its holdings. The budget deficit was $53 billion a year ago. US Treasuries gained for four consecutive trading days and traded with strength ahead of the Fed's interest rate decision. A flattening curve in a combination of short-term interest rates moving up and longer-term interest rates falling suggests the rate hikes are likely to hurt growth and cool the economy.
In a statement Wednesday, the policymakers said that "the labor market has continued to strengthen and that economic activity has been rising moderately so far this year".
They increased their projections for economic growth this year to 2.2 percent from the 2.1 percent they forecast in March. "The Fed's insouciance about market pricing for the peak of the rate cycle, along with the fall in wage growth and inflation since the start of the year, is behind both the dollar's relative softness, and markets" overall buoyancy.
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A retreat in inflation over the past two months has caused jitters that the shortfall, if sustained, could alter the pace of future rate hikes.
"We expect unchanged "dots" signalling three hikes per year and see limited chance of a hawkish surprise", Danske adds.
The Fed's preferred measure of underlying inflation has retreated to 1.5 percent, from 1.8 percent earlier this year, and has run below the central bank's 2 percent target for more than five years.
She declined to say whether she would like to serve a second term.
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