US: Policy issues remain - HSBC

In September, the Federal Reserve announced that it will tighten monetary policy by reversing some of the quantitative easing (QE) put in place during the 2008/09 financial crisis and its aftermath, points out the research team at HSBC.

Key Quotes

“The Fed plans to reinvest principal payments from its portfolio of securities only to the extent that they exceed gradually rising caps. For Q4 2017 the cap was set at USD6bn per month for Treasury securities and at USD4bn per month for agency MBS. Over the next four quarters the monthly caps are scheduled to increase to USD30bn for Treasuries and to USD20bn for agency MBS.”

“In 2018, we estimate that the Fed will disinvest about USD230bn in Treasury securities and about USD170bn in agency MBS. USD230bn in Treasury securities is equal to about 2% of the USD11.6trn in marketable Treasury debt currently held by investors other than the Federal Reserve. Our interest rate strategists think that the Treasury will refinance this debt by issuing mostly Treasury bills rather than longer-dated bonds. The estimated USD170bn in agency MBS will add about 3.5% to the supply of agency MBS held by investors other than the Fed in 2018. Reversing QE will also reduce the supply of bank reserves and gradually tighten money market conditions, in our view. The reduction in bank reserves could act as a substitute for increases in the federal funds rate. This is one of the reasons why we expect the FOMC to raise the federal funds rate only twice in the coming year, once in December 2017 and once in March 2018.”

“The fiscal policy outlook remains clouded. Fiscal 2018 begins in October. In September, rather than passing a budget law for all of FY2018, Congress adopted a temporary “continuing resolution” budget that will expire on 8 December. In the interim, leaders of the majority Republican Party intend to craft tax reform legislation aimed at boosting business investment by lowering effective tax rates while at the same time broadening the tax base with the elimination of certain deductions and exemptions. We expect a modest tax reform bill to pass through Congress and give a boost to GDP growth in 2018. However, the timing of the tax changes are uncertain.”

“Risks

A slowdown in the growth of business investment spending is a risk if tax reform is delayed for too long. There is also a risk that the Fed could tighten policy too much in 2018 as it combines balance sheet reduction with further rate hikes.”