CRB Fundamental Market Service
FOMC's balance sheet roll-off program will certainly have more impact than "watching paint dry"

The markets took this week's FOMC meeting in stride. The FOMC raised its funds rate target by another 25 bp to 1.00%-1.25% and announced the details of its balance sheet roll-off program.

Fed Chair Yellen's post-meeting comments were a little hawkish because she waived off the recent weakness in inflation as transitory and suggested there would be no impact on the Fed's near-term rate-hike intentions. In addition, the Fed-dot median was left unchanged with FOMC members still anticipating roughly three rate hikes per year through 2019.

The Fed's balance sheet roll-off program was generally in line with market expectations and did not raise any major concerns in the markets as yet. Fed Chair Yellen in her post-meeting press conference reiterated remarks by other Fed officials by saying that the program will be like "watching paint dry."

While Ms. Yellen's attempt to sooth the markets was admirable, we disagree that the program will have negligible impact. Indeed, the maximum $50 billion per month roll-off amount is only 40% smaller than the Fed's QE3 program in 2012-2014 in which the Fed bought $85 billion per month worth of securities. If the Fed thought it was having an impact by buying $85 billion per month of securities in QE3, then it is hard for the Fed to now argue that its roll-off program, which is only 40% smaller, will have virtually no impact.

The Fed will start its roll-off program at $10 billion per month and will increase the roll-off cap by $10 billion per quarter until it reaches the maximum amount of $50 billion per month. The Fed is leaving the end-point of the program open-ended until it decides on the optimal level of its balance sheet. The Fed did not say when the program will begin, but we suspect the program may begin on October 1 in order to be coincident with calendar quarters.

The Fed in just the past 6 months has raised the funds rate three times by a total of 75 bp and has announced its balance sheet roll-off program. Nothing has broken yet. However, as the Fed continues on with its rate-hike regime and balance sheet roll-off program, the cumulative risks increase for an eventual crack in the economy and the stock market.

See attached PDF file for full 13-page report