Despite the slower growth in the first quarter and a drop in inflation in March, the Federal Reserve is full steam ahead with its plan to raise short-term interests rates two more times this year. The U.S. economy grew at 0.7% in the first quarter of this year well below expectations and below the 2.1% growth in the fourth quarter of 2016.
The Federal Reserve’s Open Market Committee (FOMC) met last week to discuss interest rates in the United States and update their outlook for the rest of the year. As expected, they did not change short-term interest rates. The FOMC however, did not change their outlook for the remainder of the year.
The FOMC stated that the slower growth in the first quarter is “likely to be transitory”. They still expect the economy to rise at a moderate pace, labor markets continue to strengthen and inflation to stabilize around 2%. After the meeting, market expectations for a rate hike at the next FOMC meeting in June rose to 100%.
The bigger question mark with the Federal Reserve is when and how will they reduce the balance sheet. After the recession, the FOMC lowered interest rates. When that did not spur economic growth, they began purchasing government bonds as a way to provide liquidity to the financial system. The Federal Reserve used several rounds of these purchases called quantitative easing to stabilize the U.S. economy. When the quantitative easing programs ended, the Federal Reserve owned over $4 trillion U.S. bonds. Since that time, the Federal Reserve has maintained the balance. As one bond matures, they purchase a new one to replace the balance. How is the Federal Reserve going to reduce their holdings without disrupting financial markets?
The Federal Reserve has not released a firm plan to reduce the balance sheet. They are leaning toward starting the process this year. They are in favor of letting bonds roll off which means letting bonds mature and not replacing with new bonds. The indications are the Federal Reserve plans on informing the market “well in advance” of making any changes to the balance sheet. These steps should help reduce the impact on the financial markets.
We take Fed members at their word that changes to its policies will be well-publicized well in advance of their occurrence. However, the fact remains that steps to shrink the balance sheet could have a significant impact on financial markets, particularly for longer-dated government bonds.
Will rising interest rates have an impact on you? We can show you how to quantify the impact on you or your business and minimize any negative effects while taking advantage of opportunities. If you have any questions on the Federal Reserve and interest rates, please contact the Security National Bank Wealth Management team.
Back to Articles