Fed’s Plan to Downsize its Balance Sheet…Reflecting Policy Normalization(Current Issue No. 2850 Full Ed.)

As reflected in their latest “dot plot”, another Fed Funds Rate hike could be possible this year. But what is quite beyond the market expectation for the June FOMC meeting is the important disclosure about Fed balance sheet management. In any case, KResearch views the set-off of balance sheet downsizing, which may be only a few months away, would be unlikely to produce any significant impact on their rate uptrend over the remainder of this year. Gradual rate hikes could continue into next year, as planned, to alleviate the effects of heightened inflation; the Fed forecasts that US inflation could reach their target of 2 percent in 2018.

Looking into the components of the Fed's latest balance sheet, KResearch views that four years would likely be needed for balance sheet normalization from the current USD4.5 trillion down to USD2.5 trillion if the process begins during 4Q17 (through reduced reinvestments in maturing instruments down to their ceiling). This direction may define the Fed's stance toward normalization that it should be carried out gradually, step-by-step, toward balance sheet reductions and interest rate increases to avoid any adverse reactions in global financial markets, USD movements or US government bond yields.

Considering the possible impacts of this on Thai markets over the rest of this year, the spread between Thai and US policy rates may close in toward each other by the end of 3Q17. However, we believe that Thailand's Monetary Policy Committee may hold their policy rate unchanged at 1.50 percent until the yearend in support of our economic recovery. As for the Thai Baht, it may gradually soften due to the stringent Fed measures mentioned above. But given US political problems right now, the USD may be adversely affected anyway. All in all, any USD recovery could be limited with uncertainties during 2H17 looming large, despite strict Fed financial policies.