Quickie from WPAC on Yellen's testimony
- The key question on the market's mind at the moment, whether balance sheet normalisation will limit the scale of fed fund rate increases in coming years, was not discussed directly
- However, Chair Yellen's calm and considered detailing of the planned program emphasises that she believes (or at least hopes) that the run-off of the balance sheet will not impede the FOMC's ability to use its prime policy tool - the federal funds rate
- The limits of balance sheet normalisation will start at a very low level. Further, as Chair Yellen noted during Q&A, it is not anticipated that the caps on Treasuries and MBS will even be binding in most months - that is maturities (and therefore run-off) will be less than the cap level.
- Further, the Fed is likely to mange their re-investment activities very carefully to limit the impact of the run-off on market interest rates. As a result, the first six to twelve months of the program is likely to pass without issue. Thereafter, there will arguably be cause for careful assessment of the market's reaction and the consequences for the economy - as per recent comments by Fed Governor Brainard and Minneapolis Fed President Kaskari.
- The conclusion to draw from this testimony is that Chair Yellen and the Committee will push ahead with a third rate hike in 2017 and the commencement of balance sheet normalisation. Two further hikes in 2018 will likely be justified by conditions and unimpeded by balance sheet reduction. However, the case for additional hikes thereafter is nowhere near being made.
