The Federal Reserve balance sheet shrunk?

16 February, 2017

The Dollar has cut through a significant resistance level of 101, thus completing the retracement move after rallying to a maximum of a 14-year peak. It was not without the help from the Federal Reserve. Speaking to Congress on Tuesday, FED Chairman Janet Yellen did not disappoint the markets and clarified some information about the increase of the interest rates timing. Once again, the FED chief escaped with a formulaic statement that the decision depends on the incoming inflation and labour market data. However, according to Yellen keeping the excessive stimulation of the economy FED risks to be faced with a need of sharp rise in interest rates, to keep the monetary policy in line with the economic conditions. This, in turn, is fraught with a shock in the financial markets and returning back to the recession.

At the same time, there was not a single hint provided for financial markets about the timeframe of rate hikes. The absence of consumer spending data and the labour market situation for February dramatically limits the time horizon for making predictions. Based on the growing confidence of the FED and the Trump plans, markets prices in a 34% chance of a rate increase in March.

Another matter of concern for investors was the Federal Reserve balance sheet, swelled from $900 billion to $4.5 trillion Dollars, as a result of measures to rescue the economy from the mortgage crisis of 2007. Investors considered the possibility of a sale for those assets added to the FED toolkit, which would help to correct the long-term rates priced in the bond market. Yellen confirmed that the balance is expected to decrease to “substantially smaller” size, but the process should be “orderly and predictable.” The FED chief has excluded the possibility of using the experience of the Bank of Japan by targeting yield curve, as she believes the effect is unlikely to go beyond the bonds market.

Another important growth driver for the US currency is Trump’s tax plan which is due to be released in 1-3 weeks. Sticking on a one-month high US Dollar is reluctant to try to head north so the rumours fueled rally is not likely to happen. US data on inflation and advance retail sales in the limelight today, which promises some volatility on Dollar and will allow investors to complete the picture of the upcoming Fed actions.

Pound demonstrates a weak downward trend in anticipation of wage and unemployment data. Inflation slowed in January as a report showed on Tuesday, what may show a complex problem which affected the labour market as well. The potential for an upsurge on the Pound remains a big question mark while the break of support of 1.2450 is likely to happen.

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