Janet Yellen confirmed on Wednesday evening that the Federal Reserve now intend to wind down their balance sheet. This will at first be achieved by phasing out the reinvestment of the payments it receives on the portfolio of bonds it now holds as a result of its policies to reinvigorate the US economy. Goldilocks appears alive and well as the Fed raised growth forecasts whilst lowering inflation expectations for the current year. The Fed confirmed the balance sheet reduction will start in October and prepared the markets for a rate rise in December.
How did bond and currency markets react? Muted is the phrase that comes to mind. The US dollar strengthened about 1% against its basket of currencies, ten and two-year Treasury yields rose in tandem by about 5 basis points. The yield on the ten years has risen from the lows of just over 2% at the start of the month, to nearly 2.27% as of the close on Wednesday, after Janet Yellen’s comments. However, the curve really has not steepened a great deal, from the start of the month. With an improving economic outlook, one continues to anticipate some steepening of the yield curve to reflect the greater risk this poses to bond investors. The equity market remained resilient to the slightly hawkish tone of the speech. This would suggest either investors continue to believe the upcoming earnings season will reinforce the investment outlook, or perhaps they may be underestimating the Fed’s determination to raise interest rates in the coming months. The bond market would tend to support the latter view.
The pound `continues to remain resilient against both the euro and the US dollar after the recovery of the past couple of weeks. Mark Carney’s comments at the start of the week, and the public spat between Boris and Theresa post the Foreign Secretary’s Telegraph article on Brexit has not so far appeared to have had much of an impact. In an attempt to show unity ahead of Theresa May’s Brexit speech later Friday, Boris Johnson and Phillip Hammond, both of whom had been accused in the past of undermining the prime minister's position and risking a worse outcome for Brexit came from a cabinet meeting stating that the prime minister has everyone’s backing.
One surprising piece of data out this week, despite the widening gap in real earnings reported in August this did not prevent the British public heading to the high street. The latest retail sales data for August reported a 1% rise month on month against an expected 0.2%. Although one month does not make a trend, this piece of data would probably help reinforce the pounds recent rise.