Since June 2022, the Federal Reserve has been reducing its balance sheet to restrict liquidity in financial markets in response to elevated inflation levels. Initially, the Fed reduced its monthly reinvestments by $60 billion in U.S. Treasuries and $35 billion in mortgage-backed securities (MBS), amounting to a total reduction of $95 billion per month. By June 2024, the Fed announced a slowdown in its balance sheet reduction pace, lowering the amount of U.S. Treasuries not reinvested to $25 billion per month, bringing the overall reduction amount down to $60 billion.

The Fed’s balance sheet size has decreased from a peak of approximately $9 trillion in May 2022 to around $7 trillion currently. Following the Fed’s decision to cut rates by 50 basis points in September 2024, discussions about potentially halting balance sheet reductions have intensified. Market attention has focused on the Fed’s overnight reverse repurchase (RRP) operations, which have seen volumes decline steadily. This tool allows the Fed to absorb excess liquidity by selling securities to counterparties and repurchasing them the next day.

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The volume of overnight RRP operations reached a peak of $2 trillion during 2022-2023 but has since fallen to below $200 billion, indicating a steady reduction in excess liquidity within the financial system. This trend has raised concerns among market participants about potential tightening of market liquidity if the decline continues.

However, an examination of the Fed’s balance sheet structure reveals that, despite the decline in RRP volumes to approximately $144 billion, reserves held by banks at the Fed remain at a historically high level of around $3.2 trillion. Therefore, market expectations of continued rate cuts by the Fed suggest that overall liquidity remains sufficient.

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Additionally, in October 2024, the Fed introduced a new liquidity monitoring tool—the Reserve Demand Elasticity (RDE) indicator. A lower RDE value implies that changes in reserve demand have a more significant impact on interest rates, signaling tighter reserves. Current data shows that the RDE remains near zero, indicating stable liquidity conditions. Moving forward, attention will be focused on whether the Fed adjusts or halts balance sheet reductions before the depletion of RRP operations.

(Source: Federal Reserve Bank of New York)

The U.S. Federal Reserve announced a 25 bps rate cut to 4.5%-4.75% at its monetary policy meeting on November 7, aligning with market expectations.

In its statement, the Fed removed the phrase “job gain have slow” and replaced it with “Since earlier in the year, labor market conditions have generally eased.” Additionally, the Fed dropped the language stating it had “greater confidence that inflation is moving sustainably toward 2 percent,” and reaffirmed the committee’s view that risks related to both inflation and employment are now roughly balanced.

Regarding future monetary policy adjustments, the Fed eliminated the reference to “the progress on inflation and the balance of risks” and reiterated that it will continue to base rate adjustments on current economic data, outlook, and the balance of risks. The Fed also emphasized that it will persist in reducing its holdings of Treasury securities, agency debt, and MBS to achieve maximum employment and a return to 2% inflation.

Overall, the Fed’s stance has shifted from the highly dovish position in September to a more neutral one. Unlike the previous meeting, where one member dissented on a 50 bps rate cut, this time all members supported a 25 bps cut, reflecting the resilience of the U.S. economy and a diminished perception of downside economic risks.

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According to FedWatch data, the market now anticipates that the Fed will cut rates by 25 bps each in January, March, and June of 2025, bringing the rate down to 3.75%-4%, compared to the previous expectation of four 25 bps cuts in 2025.

(Source: FedWatch)

Post-Meeting Press Conference Q&A Highlights

Q1: One year ago, the 10-year Treasury yield was at 5%, while the 30-year mortgage rate stood at 8%. At the time, the Federal Reserve expressed concerns that further rate increases could pressure the economy. Now, despite the Fed easing restrictive policies, the 10-year Treasury yield continues to climb. How does this differ from the risks seen a year ago?
A1: The Federal Reserve acknowledges the rise in Treasury yields. However, these increases may more accurately reflect stronger-than-expected U.S. economic growth or a reduction in downside risks related to a potential recession.

Q2: Given the current economic environment, is the September SEP (Summary of Economic Projections) rate path still relevant?
A2: Overall, economic performance has indeed surpassed expectations. The upward revisions in NIPA (National Income and Product Accounts), strong September employment, and robust October retail data all support this view. As a result, downside economic risks have diminished, and we will continue to incorporate such factors into our assessments. Additionally, we have upcoming reports in December, including one more employment report, two inflation reports, and other economic data, which we will use to inform further policy decisions.

Q3: The latest PCE (Personal Consumption Expenditures) growth is 2.1%, which is very close to the Fed’s target, yet core PCE remains at 2.7% and has been steady at this level since July. Why did these figures not prompt the Fed to pause rate cuts at this meeting?
A3: The 3-month and 6-month annualized core PCE growth stands at 2.3%, indicating notable progress on inflation. However, we expect some volatility. For example, the core PCE annual growth rate was exceptionally low in the last three months of last year but saw a seasonal uptick in January 2024. We anticipate further declines by February next year. Currently, core PCE excluding housing services and goods (approximately 80% of core PCE) has already fallen to 2%—comparable to levels in 2000—and housing services inflation should ease as new lease agreements are signed. Moreover, labor market conditions are no longer contributing to inflationary pressures. While we are not declaring a full victory over inflation, we are confident that inflation can steadily decline to 2% within this scenario without being disrupted by one or two months of short-term data fluctuations.

Q4: Is the Federal Reserve actively working toward achieving a neutral rate, or does the Fed have a timeline for reaching this neutral rate target?
A4: Given the current economic landscape, the Federal Reserve is not rushing to reach a neutral rate. As long as the economy remains strong, we believe we can identify a reasonable rate path that balances the risks of easing policy too quickly or too slowly.

Comparison of the September and July FOMC Statements

U.S. economic activity remained stable across most regions, according to the Beige Book released by the Federal Reserve on October 23, and it lowered market expectations for further rate cuts.

A survey conducted by the 12 Federal Reserve Banks showed that economic activity was flat in most regions, with only two districts reporting slight growth. Overall employment saw modest increases, with more than half of the regions reporting slight or moderate job growth, while wage growth continued to slow in several areas.

Prices continued to rise moderately, though businesses in many regions noted that input costs were increasing faster than their selling prices, leading to profit margin compression. Consumer spending showed mixed results, with some regions observing a shift towards less expensive substitute goods.

In terms of business activity, the report indicated that manufacturing activity declined in most regions. The banking sector remained steady with mixed loan demand, but lower interest rates led some banks to express a more positive outlook. The real estate market also remained stable, with national housing inventory increasing and home prices mostly unchanged. However, uncertainty around mortgage rates kept some potential buyers in a wait-and-see mode.

Overall, the steady trends in economic activity, employment, and inflation have dampened market expectations for further rate cuts by the Federal Reserve. The yield on the 10-year U.S. Treasury bond has risen to around 4.2%, and Fed Watch data shows a 97% probability of a 25-basis-point rate cut in November.

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Following the Federal Reserve cut rate by 50 basis points in September, the November monetary policy decision is approaching, and Federal Reserve officials will enter a blackout period after October 26. Below is a summary of key remarks from Fed officials following the September monetary policy meeting regarding future monetary policy:

Mary Daly: “I haven’t seen any information that would suggest we wouldn’t continue to reduce the interest rate consistent with achieving that durable expansion.” “This is a very tight interest rate for an economy that already is on the path to 2% inflation, and I don’t want to see the labor market slow further.”

Christopher Waller: “This data is signaling that the economy may not be slowing as much as desired. While we do not want to overreact to this data or look through it, I view the totality of the data as saying monetary policy should proceed with more caution on the pace of rate cuts than was needed at the September meeting.”  “Whatever happens in the near term, my baseline still calls for reducing the policy rate gradually over the next year.”

Jeffrey Schmid: “Absent any major shocks, I am optimistic that we can achieve such a cycle, but I believe it will take a cautious and gradual approach to policy. While I support dialing back the restrictiveness of policy, my preference would be to avoid outsized moves, especially given uncertainty over the eventual destination of policy and my desire to avoid contributing to financial market volatility.”

Neel Kashkari: “Right now I am forecasting some more modest cuts over the next several quarters to get to something around neutral, but it’s going to depend on the data.”

Overall, the comments from Fed officials reflect a cautious yet accommodative stance toward future monetary policy. While some officials emphasize the importance of continued rate cuts to support economic growth, there is also a clear focus on closely monitoring data and maintaining flexibility in response to economic developments. The path ahead for monetary policy seems to favor a gradual and measured approach, with a strong emphasis on avoiding excessive market volatility and ensuring the economy remains on a sustainable growth trajectory.

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According to data released by the U.S. Census Bureau on October 17, U.S. retail sales remained strong in September. Retail sales increased by 0.4% month-over-month, exceeding both the previous month’s 0.1% growth and the market expectation of 0.3%.

Breaking down the details, 10 out of 13 major retail categories showed growth. The largest contributor was grocery store sales, which saw a 4.0% month-over-month increase, up 3.7 percentage points from the previous period. The next largest growth was seen in clothing sales, which rose by 1.5%, an increase of 2.7 percentage points from the prior month. On the downside, sales declined in categories such as furniture stores, electronics and appliance stores, and gas stations.

Core retail sales, excluding autos and gas stations, increased by 0.7% month-over-month, higher than the previous month’s 0.3%. The control group for core retail sales also posted a 0.7% increase, up from 0.3% in the previous period.

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Overall, consumer spending in the U.S. remains robust. According to a Federal Reserve research, this strength is likely being driven by higher spending among middle- and upper-income groups.

The report noted that during the pandemic, loose monetary policy and subsequent government subsidies boosted the spending power of all income groups, especially lower-income households. However, since mid-2021, spending patterns have diverged. Middle- and upper-income groups have been able to maintain or even increase their average real spending, while lower-income groups have seen a decline. As of August 2024, average spending by higher-income groups had grown by 16.7%, while lower-income groups saw only a 7.9% increase.

(Source: Federal Reserve, TrendForce)