FOMC to conclude with balance sheet normalisation announcement - Rabobank

While the ECB is still debating the optimal approach to reducing QE, the Fed stands ready to start reversing its previous QE policy as analysts at Rabobank expect the FOMC to conclude its September policy meeting with an announcement that balance sheet normalisation will commence.

Key Quotes

“Several FOMC members were already willing to start tightening at the July meeting, but the majority wanted to hold off until a later date, while accumulating information on the outlook and developments that could affect financial markets.”

“As far as the latter referred to the debt ceiling, the Pelosi-Schumer-Trump deal that shifted the deadline for a government shutdown to 8 December –and the deadline for the debt ceiling even further– has made it easier to go ahead with the balance sheet announcement. This deal also removes the need for the FOMC to resort to an implementation lag in order to avoid further market disruptions, and we therefore believe the Fed should be able to start as early as October.”

“Any announcement that balance sheet normalisation will begin shortly should have only a relatively muted impact on markets, given that the market largely expects it. Moreover, the FOMC has already fully outlined its intentions with respect to shrinking its balance sheet, having published a completely pre-determined schedule that will be put in place when normalisation starts. We therefore believe that any dollar strength as a result of the announcement should be limited.”

“Instead, we are still looking for a potentially dovish undertone in today’s communication. Despite strong CPI numbers last week –which caused expectations for a December hike to rise back to approximately 50%, after falling to around 30% prior to this release– our US Strategist Philip Marey expects that inflation in the remainder of the year will not be strong enough to maintain sufficient support in the FOMC for a third rate hike in December. Indeed, the July FOMC meeting already included a fierce debate about the inflation outlook. Therefore, markets will be interested in the new dot plot that will be released alongside today’s statement: will the median FOMC member still believe a third hike can happen this year, or has the inflation outlook weakened their resolve? Given the roughly 50/50 odds of a December hike currently being priced in, a shift in the dot plot could have a more profound impact on US rates and the currency.”