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NZ dollar gives up gains on Fed balance sheet unwinding

21 September 2017

The New Zealand dollar gave up earlier gains after the US Federal Reserve announced a plan to start shrinking its balance sheet and signalled one more rate hike later this year, remaining rangebound ahead of Saturday's general election. That inflation has been so persistently low despite economic growth and low unemployment is something of an economic mystery - everything from Amazon to cutthroat price competition between cell phone providers.

The U.S. 2-year Treasury yield hit a high of 1.430 percent, its highest level since July 6.

While the Fed has said the process will be very gradual to avoid upsetting financial markets, it will act as a slight tightening of monetary policy akin to an interest rate hike.

Mark Zandi, chief economist at Moody's Analytics, said central bankers will "look through the economic impacts of Harvey and Irma, because they know they're temporary".

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In its statement, the Fed, as expected, left rates unchanged and also said it would begin in October to reduce its approximately $4.2 trillion in holdings of U.S. Treasury bonds and mortgage-backed securities.

The Fed is expected to take the historic move to start unwinding its massive stimulus programme, concluding that the United States economy is strong enough to cope without a helping hand.

As expected the Federal Open Market Committee (FOMC) kept rates on hold at a range of 1% to 1.25%, but also announced it will begin the unwinding of the stimulus programme it began close to a decade ago on hopes the U.S. economy will continue to "perform well". Janet Yellen herself does not know whether the slowdown in inflation is transitory or persistent, she simply described the slowdown as a "mystery" and said if the fed view changes on inflation, it would require an adjustment in monetary policy.

Notably, the Fed on Wednesday lowered its long-term forecast for the federal funds rate to 2.8 percent, down from 3 percent in its June forecast.

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Fed officials continue to expect that the USA economy will expand at a moderate pace in the future. "The underlying trend of inflation still is well below the inflation target of two percent". That's because higher rates curb the investment appeal of non-yielding assets like gold.

Current Fed policy requires the central bank to reinvest the proceeds from maturing bonds.

The central bank's announcement drove bond yields higher, lifting shares in banks and other financial companies.

Before the Fed announced its decision, there were high expectations that monetary policymakers would drag interest rate expectations lower for 2017.

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Yellen again declined to address speculation about whether President Trump will nominate her for a second four-year term leading the Fed.