Minutes of Fed’s March meeting seen detailing a speedy balance sheet rundown
2022.04.06 13:16
FILE PHOTO: Federal Reserve Board building on Constitution Avenue is pictured in Washington, U.S., March 19, 2019. REUTERS/Leah Millis
By Howard Schneider
WASHINGTON (Reuters) – U.S. Federal Reserve officials on Wednesday will release more details on what’s evolving as a three-year plan to trim several trillion dollars from the stash of assets purchased to stabilize financial markets through the coronavirus pandemic, its next step in the move to tighten credit and lower inflation.
The reductions, which officials say could begin as soon as next month, were debated at the Fed’s March meeting, and minutes of that session released at 2 p.m. (1800 GMT) may indicate just how fast and how far policymakers will proceed in getting rid of the $4.6 trillion in U.S. Treasuries and mortgage-backed securities accumulated since March 2020.
Rising interest rates on home mortgages, bonds and other longer-term debt are already accounting for the Fed getting rid of perhaps $80 billion to $100 billion of assets per month, economists say, so the immediate market response may be muted.
But the plan will send a powerful signal of officials’ intent to make credit steadily more expensive and, by doing so, help lower inflation currently running at more than triple the Fed’s 2% target.
The Fed “will continue tightening monetary policy methodically through a series of interest rate increases and by starting to reduce the balance sheet at a rapid pace as soon as our May meeting,” Fed Governor and Vice-Chair nominee Lael Brainard said on Tuesday. Referring to the 2017-2019 period when the Fed took a year to reach a pace of $50 billion in monthly reductions of its holdings, Brainard said “I expect the balance sheet to shrink considerably more rapidly” this time.
Last month the central bank raised its target federal funds rate by a quarter percentage point, the first of an anticipated series of hikes this year and into next.
Fed officials as of March projected six more quarter-point increases this year, and the minutes may also provide insight on that debate, which has already shifted in favor of larger half-point hikes at one or more of their upcoming sessions. Traders in federal funds futures contracts expect an aggressive Fed will use half-point increases at three upcoming meetings in what may be one of the fastest tightening cycles since at least the 1960s.
For a related graphic on The Fed’s last windown: Treasuries, click https://tmsnrt.rs/3uWX0cf
‘FULLY PRICED’
Shrinking the balance sheet adds even more pressure to credit markets by decreasing demand for the assets that the Fed holds, which adds upward pressure on interest rates. While estimates of the impact vary, Fed Chair Jerome Powell after March’s meeting said the reductions might have the same effect as an additional quarter-point increase in the short-term rate the Fed uses as its primary tool.
Lorie Logan, a top market official at the New York Fed, last month estimated that by not reinvesting the monthly payments it receives on its assets, the Fed could shed an average of $80 billion a month in Treasuries and $25 billion in MBS.
Most analysts expect somewhat smaller amounts, but absent a major surprise in Wednesday’s minutes “the market is fully priced” for the Fed to reduce its balance sheet by perhaps $3 trillion over three years, said RSM chief economist Joe Brusuelas.
Details of the plan and the language from Brainard and others, he said, at this point “appear to be aimed at keeping (inflation) expectations anchored” by following through on a shift officials have been publicly discussing since last fall.
Powell laid out the broad contours of the plan when he told Congress last month the Fed would “in the range of three years” return its asset holdings to “a size relative to our economy that it was before” the pandemic.
In response to the 2007-2009 financial crisis, the Fed through several rounds of “quantitative easing” accumulated around $4.2 trillion of assets, the equivalent of around 24% of U.S. gross domestic product. From 2017 to 2019 it reduced those holdings to less than $3.6 trillion, or about 16.5% of GDP.
For a related graphic on QE, QT and GDP, click https://tmsnrt.rs/3x6ioOQ
‘IN THE BACKGROUND’
More is in play this time. The Fed between March 2020 and March 2022 ran its Treasury and mortgage holdings up to $8.5 trillion, roughly 35% of GDP, a level some elected officials worried put the central bank too deeply into financial markets and government finance.
As the Fed begins its withdrawal, economists expect it may end up targeting a balance sheet level equivalent to perhaps 20% of GDP, or around $6 trillion depending on how fast the economy grows and, perhaps more importantly, what level of reserves commercial banks require.
Policymakers have said they do not want to repeat their mistake of 2019, when the balance sheet got so low it drove up the interest banks charge each other to borrow reserves overnight. That forced the Fed to put more cash into the system.
“They want this to operate in the background so they will be very careful about the language they use,” said Andrew Patterson, senior international economist for Vanguard.
Patterson said he thought the Fed would aim to reduce the balance sheet to around “20ish” percent of GDP, but may take four or five years to get there, a slightly slower pace than Powell flagged to Congress.
Whatever the parameters set, New York Fed President John Williams said Saturday it will likely take a shock to the economy to change course once agreement is reached.
“The idea at least during the initial phase is to have that operate in a very predictable way, in the background,” Williams said.
For a related graphic on The Fed’s potential drawdown, click https://tmsnrt.rs/3LMHaI7
