Starting from June, the QT slowdown! The Federal Reserve maintains high interest rates as scheduled, with the scale of the reduction in US Treasury holdings more than halved, warning of a lack of progress in inflation

As expected by the market, the Federal Reserve continued to maintain high interest rates and announced the landing of the plan to reduce quantitative easing (QT).

On Wednesday, May 1st, Eastern Time, after the Federal Open Market Committee (FOMC) meeting, the Federal Reserve announced that the target range for the federal funds rate remains at 5.25% to 5.50%. Since the rate hike in July last year, this policy rate of the Fed has remained at a high level for over twenty years.

In this current tightening cycle that started in March 2022, the Federal Reserve has not raised interest rates for six consecutive meetings. Similar to the previous 14 meetings since July 2022, all FOMC voting members supported the interest rate decision this time.

Compared to the decision after the March meeting, a major change in this Federal Reserve decision is reflected in the action plan to reduce the balance sheet. The Fed has cut more than half of the upper limit of the monthly planned reduction in the size of U.S. Treasury holdings. Some commentators have pointed out that the announced reduction of $35 billion by the Fed exceeds Wall Street's expectation of $30 billion.

Another major change in this decision is that the Federal Reserve warned of a lack of further progress in inflation decline recently. Journalist Nick Timiraos, known as the "New Fed News Agency," directly stated in the headline that the Fed believes progress in inflation decline has stalled, with the headline reading "Fed Says Inflation Progress Has Stalled and Extends Wait-and-See Rate Stance."

Timiraos began the article by stating that the Fed acknowledges recent setbacks in inflation decline and extends the wait-and-see period. If the economy does not weaken, this wait-and-see attitude by the Fed may continue for the rest of the year.

Both the decision to maintain interest rates and to slow down the balance sheet reduction are in line with market expectations. With inflation indicators exceeding expectations in recent months and Fed officials' hawkish comments, the market expects a reduced likelihood of rate cuts by the Fed this year and a delay in the timing of rate cuts. According to CME tools, as of Tuesday's close, the futures market predicts that the probability of a rate cut by the Fed will not exceed 50% until September this year, slightly exceeding 56% in November, and over 70% in December.

Monthly Cap on U.S. Treasury Balance Sheet Reduction Reduced by $35 Billion to $25 Billion, Institutional MBS Cap Unchanged

Compared to the March statement, the Federal Reserve's decision statement this time mainly adjusted the plan for balance sheet reduction. Firstly, the Fed reiterated that it will continue to reduce U.S. Treasuries, agency debt, and institutional MBS, and then added the following statement:

Starting in June, by lowering the monthly cap on the redemption of U.S. Treasuries from $60 billion to $25 billion, the (FOMC) committee will slow down the reduction of bonds held. The committee will keep the monthly cap on the redemption of agency debt and institutional MBS at $35 billion unchanged, and any principal exceeding this limit will be reinvested in U.S. Treasuries.

This is the first time since June 2022 that the Federal Reserve has modified the wording of the balance sheet reduction plan in its decision statement. Prior to this significant change, the Fed had already signaled a slowdown in balance sheet reduction after the March meeting At the press conference after the March meeting, Federal Reserve Chairman Powell stated that the reduction of Quantitative Tightening (QT) will happen "very soon". The minutes released in April showed that at the March meeting, most Fed policymakers leaned towards slowing down the balance sheet reduction soon. Policymakers generally agreed to reduce the overall monthly bond reduction by about half, not adjust the cap on Mortgage-Backed Securities (MBS) reduction, but reduce the size of U.S. Treasury bonds.

Continues to emphasize the need for more confidence in inflation reaching 2% before cutting rates

Regarding interest rate guidance, this decision statement completely copied the wording of the previous two decisions in January and March this year, continuing to emphasize:

"When considering any adjustments to the target range for the federal funds rate, the (FOMC) Committee will carefully assess future data, evolving outlooks, and risk balances. The Committee expects to be confident in moving towards 2% inflation before considering lowering the (interest rate) target range."

The statement continued to emphasize the Fed's commitment to bringing the inflation rate back to the 2% target.

New mention of the lack of further progress in inflation decline in recent months, reiterating the increasing balance of risks for employment and inflation targets

In assessing economic activity, compared to the previous statement of "economic activity expanding at a moderate pace," this time added "continuing" once, stating that economic activity continues to expand at a moderate pace. This statement reiterated that job growth remains strong and the unemployment rate remains low.

Regarding inflation, this statement continued to reiterate the assessment of inflation slowing down from the December statement last year, namely "inflation has slowed over the past year but remains high." The difference from the previous statement is that following this sentence, a new sentence was added:

In recent months, there has been a lack of further progress in achieving the (FOMC) Committee's 2% inflation target.

The January Fed statement added the expression "risks to achieving employment and inflation targets are moving towards a better balance." This statement did not completely repeat this sentence as in March, but added a time limit, stating that "over the past year, risks to achieving employment and inflation targets are moving towards a better balance."

Then this statement continued to reiterate the addition from January about "uncertain economic outlook," and continued to emphasize that the Fed "remains highly concerned about inflation risks."

The red text below shows the deletions and additions in this decision statement compared to the previous one.