(Reuters) - The Federal Reserve on Wednesday said it would leave interest rates unchanged and announced plans to slow the speed of its balance sheet drawdown, after having spent much of the earlier part of the year warning of this shift.

The Fed said that starting on June 1 it was reducing the cap on Treasury securities it allows to mature and not be replaced to $25 billion from its current cap of up to $60 billion per month. The Fed left the cap on how many mortgage-backed securities it will allow to roll off its books at $35 billion per month, and it will reinvest any excess MBS principal payments into Treasuries.

The announcements came at the end of its two-day Federal Open Market Committee meeting. It was widely expected to leave policy rate at 5.25%-5.50% but signaled it is still leaning towards eventual reductions in borrowing costs. It put a red flag on recent disappointing inflation readings and suggested a possible stall in the movement towards more balance in the economy.

MARKET REACTION:

STOCKS: The S&P 500 pared a slight loss to -0.15%,

BONDS: The yield on benchmark U.S. 10-year notes eased a bit to 4.637%. The 2-year note yield ticked down to 5.002%

FOREX: The dollar index extended a loss to -0.15% with the euro a bit higher, up 0.19%

COMMENTS:

BRIAN JACOBSEN, CHIEF ECONOMIST, ANNEX WEALTH MANAGEMENT, MENOMONEE FALLS, WISCONSIN"The Fed finally recognized that their balance sheet reduction was doing more harm than good. It wasn't helping bring down inflation. It was just increasing bond market volatility. Financial stability concerns need to dominate their thinking. The Fed needs to use the right tool for the right job: rates for inflation and its balance sheet for financial stability."

MICHELE RANERI, VICE PRESIDENT OF U.S. RESEARCH AND CONSULTING, TRANSUNION, CHICAGO (by email)

"The new GDP report is a likely indicator that the Fed's previously announced 'higher for longer' interest rates are not going away any time soon. U.S. consumers should be prepared to continue to face relatively high interest rates across a range of credit products for a while longer, with any potential rate decreases likely being pushed to later in 2024."

"Ultimately, this could result in the mortgage and auto markets remaining relatively sluggish as consumers continue to wait for rates to fall. Indeed, if interest rates do not begin to decline until later in 2024, this could mean that many home buyers may hold off until later 2024 or even into 2025."

MATTHAIS SCHEIBER, GLOBAL HEAD OF PORTFOLIO MANAGEMENT, SYSTEMATIC EDGE TEAM, ALLSPRING GLOBAL INVESTMENTS, LONDON (email)"As expected, the Federal Open Market Committee decided to keep its key interest rate, the federal funds rate, unchanged at 5.25-5.50%. We believe the Federal Reserve (Fed) won't cut rates until it sees weakening in prices and labor market data--probably not before fall."In addition to the fact that core goods' deflationary impact on U.S. inflation is currently stalled, the positive base effects from 2023's falling energy prices will wash out now. Service prices, which represent the largest driver of current inflation, have stabilized over the past three months after dropping meaningfully last year. The good news is that inflation's breadth (how many goods and services are increasing at the same time) is coming down further. However, inflation's persistence (how sticky inflation will be) has reaccelerated again. As a consequence, the short-term interest rate market has readjusted and is now more pessimistic on rate cuts: Compared with the Fed's estimate of three rate cuts in 2024, the market--which originally anticipated five 2024 rate cuts--now expects just one.

"Our base case is for the Fed to hold until inflation and growth data weaken enough to justify less restrictive monetary policy. These conditions should be met by late in the third quarter of this year."

"We continue to favor bonds, which benefit from moderating growth and moderating inflation-particularly internationally. We also continue to like equities. Despite a short-term struggle, earnings and guidance have remained robust and any relief from perceived looser monetary policy would likely support equity prices in the medium term."

(Compiled by the Global Finance & Markets Breaking News team)