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The Fed is poised to pare back its balance sheet

July 2017

Despite a raft of fresh problems for President Trump’s administration, US equity markets rose during July and the Dow Jones Industrial Average Index reached a new closing high at the end of the month. The Fed is poised to begin paring back its balance sheet. President Trump’s attempt to repeal Obamacare collapsed during the month and there was further turmoil in the White House as Mr Trump’s team changed again.

  • The US economy grew by 2.6% YoY in Q2
  • Disappointing wage growth undermined expectations for inflation
  • The FOMC maintained its key interest rate at 1%-1.25%

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Fresh political problems for the Trump administration did not prevent US equity markets from rising during July. The Dow Jones Industrial Average Index hit a fresh closing high at the end of the month, stoked by a strong second-quarter corporate earnings season. Over July as a whole, the Dow Jones Industrial Average Index rose by 2.5% and the S&P 500 Index climbed by 1.9%, while the technology-rich Nasdaq Index posted a monthly gain of 3.4%

“The Dow Jones Industrial Average Index hit a fresh closing high”

Having expanded by 1.2% during the first three months of 2017, US economic growth continued to gain traction over the second quarter, rising at an annualised rate of 2.6%. The International Monetary Fund (IMF) downgraded its forecast for US economic growth in 2017 from 2.3% to 2.1% and in 2018 from 2.5% to 2.1%, citing “the assumption that fiscal policy will be less expansionary going forward than previously assumed”.

The Republican Party failed to replace Obamacare as part of its flagship move to revamp the country’s health care system, and there was further confusion in the White House amid a series of changes to President Trump’s team. Looking ahead, expectations that President Trump will be able to implement his planned high-growth expansionary policies appear to be losing some of their momentum.

Nevertheless, in a move that was construed as a sign of confidence in the US economy, the Federal Reserve (Fed) indicated that it is ready to begin cutting back its balance sheet, perhaps as early as policymakers’ next meeting in September. The Federal Open Market Committee (FOMC) maintained its key interest rate at 1% to 1.25% at its July meeting, but announced that it intends to begin trimming its balance sheet “relatively soon” if the US economy remains on target.

Although the country’s rate of inflation has softened somewhat, Fed officials do not appear unduly concerned about the inflationary outlook, and still expects inflation to stabilise around the target rate of 2% in the medium term. The annualised rate of consumer price inflation remained unchanged at 1.6% in June, having fallen steadily since February, when it hit 2.7%. Although investors welcomed some encouraging labour market data – the US economy added 222,000 new jobs during June, compared with a three-month average of 194,000 per month – disappointing news on wage growth undermined expectations for stronger inflation as annualised wage growth remained relatively subdued at 2.5%.

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