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Fed hikes rates, lays out plan to unwind $4.5 trillion balance sheet

The Fed is finally on a path to winding down its nine-year stimulus program.

After its two-day policy meeting, the Federal Reserve raised its benchmark interest rate, the third time in six months, stuck to its forecast of one more hike this year and laid out plans to unwind its balance sheet.

The Federal Open Market Committee (FOMC) voted to raise the range of the federal funds rate to 1.00% and 1.25%, citing mixed economic data.

“In view of realized and expected labor market conditions and inflation, the Committee decided to raise…the fed funds rate,” the central bank wrote in its statement.

One member of the committee, Minneapolis Fed President Neel Kashkari, voted against the decision, preferring to keep the federal funds rate between 0.75% and 1.00%. In March, Kashkari was also the lone dissenter to raising rates.

Unwinding the balance sheet

The Fed also described its plans to wind down its $4.5 trillion balance sheet, which it expects to begin this year. The program, in which the Fed would gradually reduce its holdings of Treasuries and agency securities, will decrease the Fed’s reinvestment of principal payments. Payments will only be reinvested when they exceed gradually rising caps, which start out at $6 billion per month for Treasuries and $4 billion per month for agency debt and MBS.

“The Committee currently anticipates reducing the quantity of supply of reserve balances, over time, to a level appreciably below that seen in recent years but larger than before the financial crisis; the level will reflect the banking system’s demand for reserve balances,” the Fed wrote in an addendum to its statement. The unprecedented size of the Fed’s balance sheet is a lingering a result of the extraordinary easing measures it took in response to the financial crisis.

Federal Reserve Chair Janet Yellen. (AP Photo/Cliff Owen)

Economic projections

The Fed’s cautious, yet generally positive, economic statement follows a slew of weak data, including disappointing first quarter GDP, soft inflation numbers and less-than-expected payroll gains.

Unemployment has hovered just below 5% for the past year, a level many economists consider to be near full employment. However, while the unemployment rate sank to 4.3% in May, its lowest level in over a decade, non-farm payrolls grew by a disappointing 138,000.

“Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined,” the central bank wrote in its statement. “Household spending has picked up in recent months, and business fixed investment has continued to expand.”

Meanwhile, recent inflation readings have continued to run below the Fed’s 2% target. The Fed’s preferred measure of price inflation, the core Personal Consumption Expenditures index, fell to 1.5% year-over-year in April, its lowest level in months. Another measure of inflation, the Consumer Price Index, dipped to 1.9% year-over-year in May. The Fed noted that “inflation on a 12 month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term.”

The Fed also reiterated its balance of risks statement, noting, “near-term risks to the economic outlook appear roughly balanced,” meaning that the economy is no more likely to surprise to the downside than the upside.

Fed projections and dot plots

The Fed’s expectations for GDP growth increased slightly to 2.2% in 2017, while forecasts for unemployment dropped across the board, with officials expecting the rate to hit 4.6% in the long-run. Officials also reduced their short-term outlook for core PCE inflation to 1.7% this year.

Federal Reserve

Despite recent departures of several Fed officials, projections for the total number of expected rate hikes in 2017 remained unchanged with one more quarter-point raise this year.

Officials also forecast three rate hikes in 2018, with the rate reaching 2.9% in 2019, just below its long-run goal of 3.0%.

Federal Reserve