The US Fed remains the test case for whether central banks can ever ‘normalise’ rates. We expect it to try, but fail - peaking out at a far lower policy rate (1¼-1½%) than in past US recoveries.
We update our ‘Policy Looseness Analysis’ to gauge how the US & UK’s overall - monetary & fi scal - policy positions should shift into 2018. By taking explicit account of QE, true US & UK policy rates may be as low as -4¼% & -3% respectively.
Running true rates this low would make the FOMC increasingly uncomfortable if at the same time the QE stock remains as bloated.
Selling the assets back is admittedly one for later, & would have to be done gradually to minimise the disruption to bond markets. But, as a precursor, terminating the reinvestment programme would surely be the gentlest way of tightening - in effect by ‘doing nothing’.
It would help keep peak rates low, & give comfort that central banks are not falling ‘behind the curve’. It may even go some way to reducing the downside of QE, evidenced by asset-price distortions, suppressed saving, & funding strains on many pension schemes...