The Federal Open Market Committee agreed Wednesday to increase the federal funds rate by 25 basis points to a 1% to 1.25% range, echoing a move made in March that also raised rates by 25 basis points.
The committee also expects to begin reducing its balance sheet this year, “providing that the economy evolves broadly as anticipated,” members said in a statement.
For maturing securities, the committee anticipates an initial cap of $6 billion per month that will increase by $6 billion at three-month intervals over 12 months until reaching $30 billion per month, according to an addendum to the Fed statement.
For agency debt and mortgage-backed securities, the anticipated cap is $4 billion per month initially, increasing by $4 billion at three-month intervals over 12 months until it reaches $20 billion per month. The caps are expected to remain in place once they reach their respective maximums, “until the committee judges that the Federal Reserve is holding no more securities than necessary to implement monetary policy efficiently and effectively,” the addendum said.
All but one member agreed to the rate hike. Neel Kashkari, president and CEO at the Federal Reserve Bank of Minneapolis, voted against the move, as he did in March, arguing that it was not necessary yet.
“The median path for the federal funds is essentially unchanged,” Chairwoman Janet Yellen said at a press conference following the two-day meeting, adding that additional gradual rates are likely to be appropriate over the next several years.
Committee members cited a strengthening labor market and moderately expanding economic activity for the decision to raise rates, noting that inflation has declined on a 12-month basis and is expected to stay below 2% near term, but stabilize over the medium term.
Despite the lagging inflation data, “the fact that the Fed is moving forward reflects an element of comfort that the economy continues to move in the right direction,” said Myles Clouston, senior director at Nasdaq Advisory Services, in an email. He said the initial market reaction was positive but has started to come back to breakeven. “The reaction is likely being driven by the comments that the Fed is still on track and also with the details of the balance sheet reduction. Clearly the markets have a lot to digest but so far the reaction has been mixed to positive,” said Mr. Clouston.
Robert Tipp, managing director, chief investment strategist and head of global bonds at PGIM Fixed Income, said that the signal of a balance sheet sell-off “is a little bit earlier than some might have expected, although it makes complete sense, so they don't surprise the market and they don't surprise the Treasury.”
A projected ramp-up of up to $50 billion in Treasuries per month “is a lot for the market to absorb. This is a market that is already absorbing net issuance from the government. This is kind of like (quantitative easing) in reverse,” said Mr. Tipp. If people have to buy riskier securities, “this is likely to dampen the markets a bit, more than what people might have expected.”