Monthly Archives: June 2017

Is the Fed Now Focused on Shrinkage?

Thurs, JUN 15th, 2017

George Costanza knows all too well that some shrinkage is bad. However that of the $4.5 trillion dollar variety may not be. The much-anticipated June meeting for the FOMC has come and gone. As we anticipated, in a show of confidence in the US economy the Committee raised their target fed funds rate one-quarter point to 1.00-1.25%. They also put forth a framework regarding beginning to shrink its (very large) balance sheet – i.e., the value of Treasury and MBS securities that it holds – on the path towards adjusting monetary policy in accordance with their views on what they (and we) believe is a good economy. Barron’s picked up on our post-meeting views on the Fed and interest rates.

Albion Financial Group’s Jason Ware contends the Fed’s balance sheet will take precedence over rate hikes:

As I have discussed in market meetings here at Albion over the past couple of months we believe that it is here (the balance sheet) that the Fed may – for at least the time being – pivot their focus in terms of “normalizing” monetary policy as well as providing an impetus for longer-term rates to rise. If we are right this could slow or delay the pace of future rate hikes. Indeed, we think that based on current information the next rate hike is unlikely to be before December 2017 – unless growth and inflation materially pick up before then. The monetary theory here would be to take some pressure off of the short end of the curve, while allowing (hopefully) the longer end to rise. The 2s-10s spread is currently at +0.80% and directionally has been flattening as of late. The Fed would probably like to see this begin to expand some. The caveat to this theory is that due to the glut of global liquidity in search of yield US Treasurys remain attractive on a relative basis. This could potentially neutralize or dilute the impact of the Fed’s balance sheet draw down program, at least early on. That said, at the very least the effect of this inertia is that it probably puts a floor in on longer-run Treasury yields (save for an unexpected dramatic slowdown in the US economy or an acute flight to safety trade due to some global event). Our base case is that gradually losing the full force of the Fed (the largest single holder of Treasurys) is likely to have upward drift influence on longer term yields into 2018.

You can read the entire Barron’s piece here.

Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group
(801) 487-3700