In late January, financial markets were braced for the event of crucial importance. The Federal Open Market Committee assembled for a two-day policy meeting. The US regulator changed its rhetoric baffling investors and traders.
The Fed’s policy statement left market participants in suspense. They could not figure out why the regulator radically revised its views on the state of affairs. Fed’s Chairman Jerome Powell evaded a lot of challenging questions in the following press conference. As a result, market participants were confused by so-called quantitative tightening (QT) or Fed’s stance on contracting the balance sheet in 2019.
The US central bank signaled that it could review criteria of contraction. Another unclear thing is what size of the balance sheet the Fed is aiming for. The balance sheet has been reducing for over a year as long as bonds’ maturity expires. The sheet’s size can be maintained at a particular level either through reinvesting returns gained from securities which have expired or through launching a new round of the stimulus program (QE). Another means of sustaining the balance sheet at a required level is to purchase assets. This measure also raises questions. Market participants wonder why the Federal Reserve with Jerome Powell at the helm reversed rhetoric.
Meanwhile, traders are adjusting their sentiment for markets of any type, including the debt market, the market of event derivatives, Fed funds futures etc. Experts think that the policy update, in particular contraction of the balance sheet, could influence the money supply from the US Fed and the key tool of monetary policy - the target federal funds rate.
Besides, market participants foresee notable changes in the repo market. At present, the US trade balance deficit is gradually sapping liquidity of its financial system. Some analysts warn that US bank reserves have been falling. So, US companies could find an excuse to resort to extra funding. A surge in the volume of promissory notes with short maturity could encourage an increase in interest rates in financial markets. At the moment, growing repo rates lifted short-term rates, including ones of commercial securities. Experts think that pressure on interest rates will relax, if market turmoil calms down.
