Fed Says Balance Sheet Trimming to Begin “Relatively Soon”

The U.S. Federal Reserve, as widely expected, unanimously decided line to raise interest rates this month. Going into the two-day monetary policy meeting which began on Tuesday, traders had put a less than 3 percent chance on rate hike. The Fed also laid out the groundwork to being winding down its massive stimulus program sooner than previously expected.

The Fed’s monetary policy statement contained key language that indicates the move to reduce stimulus would begin in September. At that time, the central bank will begin trimming its massive $4.5 trillion portfolio of bonds it has accrued on its balance sheet.

“The committee expects to begin implementing its balance sheet normalization program relatively soon, provided that the economy evolves broadly as anticipated,” the post-meeting statement said.

Traders are focusing on the “relatively soon” phrase. Prior to this monetary policy statement, investors had been focusing on the phrase “this year.”

As far as other changes to the Fed statement are concerned, in assessing the economy, the Federal Open Market Committee held its assessment that “activity has been rising moderately so far this year.”  On inflation, the statement removed the word “somewhat” from June’s verbiage and said simply that inflation was running “below 2 percent,” a subtle tweak that nonetheless probably signifies officials are a bit more pessimistic about reaching their mandated objectives.

Market Reaction

The CBOE Volatility Index, also called the VIX, widely considered the best gauge of fear in the market, fell Wednesday to its lowest on record.

The blue chip Dow Jones Industrial Average rose about 100 points to hit a record high after the release of the Fed statement. The benchmark S&P 500 also hit a record and the tech-based NASDAQ Composite climbed to a new all-time high.

U.S. government debt prices were lower on Wednesday. The yield on the benchmark 10-year Treasury note slipped to 2.289 percent, while the yield on the 30-year Treasury bond was down at 2.895 percent.

December Comex gold rallied after earlier weakness, but did not make a new high for the week. The September U.S. Dollar Index broke sharply from its intraday high, but failed to take out this week’s low at 93.46.

In the Forex market, the EUR/USD recovered from earlier weakness, rallying to just shy of yesterday’s two-year high at 1.1712. The USD/JPY gave back all of its earlier gains in reaction to the narrowing of the spread between U.S. government bonds and Japanese government bonds.