Michelle Gamble

Market Commentary

For the week ending 22 September 2017
Report by Michelle Gamble
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Michelle Gamble

Financial markets started the week in a calm fashion, despite US President Donald Trump’s threat to “totally destroy” North Korea, with investor attention largely focused on the outcome of the Federal Open Market Committee (FOMC) meeting.

Donald Trump delivered his first speech to the United Nations (the UN) General Assembly on Tuesday. He has relied heavily on the intergovernmental organisation over recent months to impose tough sanctions on North Korea in a bid to halt its nuclear program. Despite the UN Secretary-General warning that “fiery talk can lead to fatal misunderstandings”, Trump used the address to threaten Kim Jong-un’s regime with annihilation. North Korea responded by dismissing the rhetoric and referring to Trump as a “dog barking”.

As widely expected, the FOMC announced the gradual reduction of its $4.5trillion balance sheet, beginning in October. The Federal Reserve’s (the Fed) balance sheet expanded rapidly between 2008 and 2014. During this period, the Central Bank embarked on three rounds of quantitative easing (QE), in which they carried out unprecedentedly large-scale monthly purchases of US Treasury bonds and mortgage-backed securities, in an effort to keep borrowing costs low and boost economic growth following the financial crisis. Whilst QE was brought to an end in 2014 as the economy strengthened, the Fed kept its balance sheet high by reinvesting the proceeds of existing bonds as they matured. The process of unwinding the Fed’s balance sheet is intended to be slow and steady, beginning at just $10billion per month, to reduce the likelihood of negative implications for the wider economy.

The FOMC left interest rates on hold at the 1% – 1.25% range but surprised markets by sticking to their previous projection for one further rate hike this year and three in 2018. Market participants had anticipated that stubbornly low inflation, and the potential economic damage from Hurricanes Harvey and Irma, may have resulted in the Fed adopting a more cautious tone and pushed back their outlook for future interest rate rises. The Fed’s unexpectedly hawkish stance resulted in the US Dollar and Treasury yields surging following the announcement.

Janet Yellen’s position as Fed Chair may come to an end in February 2018 when her current term expires, if she is not reappointed by Donald Trump. Under Yellen’s leadership, the Fed has helped to steer the US to economic recovery by adopting an ultra-cautious approach to monetary tightening. The Fed has been very careful over recent months to prepare financial markets for the balance sheet reduction, and this week’s announcement marks a milestone in their efforts to normalise monetary policy. With the future of the Fed now in the hands of the unpredictable US President, the 2018 outlook for the World’s largest economy is far from certain.