Thought of the week

Last week, the Federal Reserve maintained interest rates unchanged at 2.25% – 2.50% as expected, but its communication changed to a more dovish tone, which positively surprised investors. The Committee stated that it will be “patient” and adopt a “wait-and-see” approach in determining the future path of interest rates, emphasizing that this change was not due to a deterioration of its view of the U.S. economy, but rather due to a cross-current of risks to the global economy. Also surprisingly, the FOMC released a separate statement on the balance sheet normalization process. While there was no adjustment to the current pace of unwinding at this time, the mention of this topic hinted that the Committee may be rethinking how large they might ultimately want the balance sheet to remain. While most investors pay attention to the asset side of the balance sheet, looking at the liability side instead may help explain this potential change in destination. As a result of strong increases in U.S. currency, Treasury deposits and other liabilities, excess reserves have fallen far more rapidly than assets. Because the Fed wants to have significant excess reserves on its balance sheet when it’s done with quantitative tightening, the reduction of the balance sheet might end sooner than the Fed had previously expected. Investors should recognize, however, that this change would be largely due to technical factors and not a reflection of a change in the Fed’s view of the economic backdrop

Source: JP Morgan Asset Management