The Federal Reserve on Wednesday raised rates 25 basis points to a range of 1% to 1.25%, as expected, and indicated there would be one more rate hike this year, but some analysts aren't so sure.
That's because in addition to the rate hike, the Fed laid out its plan to reduce its $4.5 trillion balance sheet, which is essentially another means of tightening monetary policy, at a time when economic growth appears to be slowing and inflation declining. The Fed indicated it could begin to implement the plan this year.
Under the plan, the Fed expects to reduce the amount of its holdings of Treasuries and mortgage-backed securities by $10 billion a month — split 60/40 between Treasuries and mortgage-backed securities — raising the cap by $10 billion in subsequent quarters until reaching $50 billion a month.
"We are now officially in the 'Reverse QE' era and it will be important for the market to prove it can digest the unwind of what many believe to have created a stock market and bond market runup," says Brett Ewing, branch manager at First Franklin Financial Services in Tallahassee, Florida. He was referring to the quantitative easing policies the Fed adopted, buying securities, to boost an economy suffering from the financial crisis.
But Ewing questioned the ability of the Fed to unwind its balance sheet and raise rates while inflation is falling. "One of them has to give," said Ewing.
He doesn't expect the Fed will raise rates again this year if it also starts to unwind its securities holdings and there are no changes in fiscal policy, such as tax cuts, that have the potential to boost growth and increase inflation.
Roger Aliaga-Diaz, Vanguard Chief Economist, Americas, agrees. "We don't anticipate inflation to rise meaningfully from current levels in the second half of the year, and believe the Fed will likely hold off implementation on any additional rate hikes — with a potential long pause through 2018," said Aliaga-Diaza, in a statement.
