Why is the Federal Reserve continuing its ‘soft’ QE program if the economy is so strong?

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Janet-Yellen

It wasn’t a big surprise for the financial markets to see the Federal Reserve hike the interest rate by 0.25% last week, and the stock market moved swiftly higher on the back of this announcement which has removed some uncertainty.

Federal Reserve Interest Rates

Source: propertyobserver.com.au

As expected, the interest rate was hiked by 0.25% citing better circumstances on the US labor market, and this move was widely anticipated and expected. What’s more important than the effective rate hike, are the comments surrounding this decision. The Federal Reserve has acknowledged the inflation rate hasn’t reached the eyed 2%  yet (well, at least not officially), and it will continue ‘to monitor actual and expected progress toward its inflation goal’. The choice of words is pretty important as the Federal Reserve also said it expects the economic conditions to remain ‘evolve in a manner that will only gradual increases in the federal funds rate’. In other words, the American economy isn’t ready yet for more rate hikes, and that’s the main reason why the markets were so enthusiast right after the announcement was published.

Maybe even more important was the statement in the final paragraph, which was a real ‘aha-erlebnis’. Despite increasing the interest rate, pretending the situation of the American economy is much better now, the Federal Reserve said it would continue to reinvest the proceeds of the maturing agency debt and mortgage backed securities as well as the income on existing securities into new ones. This basically is a continuous ‘soft’ Quantitative Easing, something we already pointed out in a previous column, published in October 2014.

Federal Reserve Balance Sheet

Source: Federal Reserve

As you can see on the previous image, the total value of the mortgage-backed securities on the balance sheet of the Federal Reserve continues to increase. Yes, it has slowed down, but if you’d zoom in on the one-year chart, you’ll clearly see the Fed’s balance sheet is still expanding and since the first week of May, the amount of MBS’ on the balance sheet has increased by an additional 2%.

Fed BS 2

Source: Federal Reserve

And if you’d look at the size of the total balance sheet of the Federal Reserve, you’ll clearly see the balance sheet hasn’t been reduced but actually has increased in the past few months. Granted, the increase is less outspoken, but the total balance sheet has expanded by roughly 1% in the past six months. Not exactly a clear sign the Federal Reserve ‘really’ believes in the US economy.

Federal Reserve Total Assets

Source: Federal Reserve

This could be seen as an indecisive move by the Fed, and the rate hike is partly being compensated by the Fed’s continuous involvement on the mortgage and asset backed securities as the total value of the MBS on the balance sheet continues to increase, as does the total amount of assets on said balance sheet.

The first step to try to convince the world (and probably themselves as well) the American economy is doing just fine has been made, but we aren’t confident to see additional steps anytime soon.

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