Fed Eyes September Announcement on Balance-Sheet Reduction

The Federal Reserve has indicated there is a strong chance they will announce a decision to start shrinking the central bank’s portfolio of bonds and other assets.


Source: Fox Business

Federal Reserve officials have indicated there is a strong chance they will announce in September a decision to start shrinking the central bank’s portfolio of bonds and other assets, while putting off until December any further interest-rate increase.

The moves would give officials time to assess how markets react to the balance-sheet reductions and to confirm their view that a recent slowdown in inflation will fade.

While a final decision on the next Fed moves hasn’t been made, officials will have several opportunities in coming weeks to clarify their thinking. The central bank releases minutes of the June meeting on Wednesday, and Chairwoman Janet Yellen testifies before Congress next week. Officials will also gather in Jackson Hole, Wyo., at the end of August for an annual monetary-policy conference that will provide ample opportunities for them to offer further guidance.

Earlier this year, some officials indicated they were considering raising interest rates in March, June and September and then starting the portfolio reduction plan in December. They did raise rates in March and June, but are considering the new strategy for several reasons.

First, they agreed at their June policy meeting on how they would reduce the $4.5 trillion portfolio, and made that plan public. Some officials now think they might as well get started soon, given the U.S. economic expansion appears steady and global growth is improving.

Second, if Ms. Yellen isn’t nominated to a second term as chair, they would prefer not to wait until December and launch the plan shortly before her successor takes charge.

Third, inflation remains a puzzle for the Fed. The unemployment rate fell to 4.3% in May, a 16-year low, yet price pressures have diminished in recent months, moving year-over-year inflation gauges further below the central bank’s 2% target.

The Fed raised its benchmark federal-funds rate to a range between 1% and 1.25% in June, the third quarter-percentage-point increase in the last three quarters.

Despite the Fed’s interest rate increases, financial conditions have mostly eased, with stock markets running to new highs and the dollar falling. Yields on the 10-year Treasury are at 2.35%, up from recent lows but below the 2.64% annual high set in March.

The Fed’s portfolio has been shrinking as a share of gross domestic product since 2014, when it stopped adding to its holdings but continued to reinvest the proceeds of maturing assets to maintain the portfolio’s size at $4.5 trillion.

The Fed said last month that when it starts allowing the holdings to decline, it will do so gradually by allowing a small amount of bonds to mature every month without any reinvestment. It would start by allowing up to $6 billion in Treasury securities and $4 billion in mortgage bonds to roll off without reinvestment, and let those amounts rise each quarter, essentially setting a speed limit for the wind-down.

The limits would ultimately rise to a maximum of $30 billion a month for Treasuries and $20 billion a month for mortgage-backed securities. Fed officials want the balance sheet wind-down to run quietly in the background, meaning they are unlikely to adjust it from one meeting to the next barring a shock to the economy.

They have taken pains to avoid a repeat of the costly 2013 “taper tantrum,” when investor concerns over the Fed’s decision to slow down asset purchases triggered market turmoil, including a sharp increase in Treasury yields.

Allowing some of the holdings to mature without reinvestment could push up long-term rates, but markets haven’t shown a significant reaction so far. Economists say that partly reflects the relatively slow pace of the initial wind-down as well as officials’ indications the balance sheet will end up at a final size that is relatively large compared with its pre-crisis level.

Officials opened the door to moving as soon as September on the portfolio when they said in their June policy statement the reduction plan could begin “this year.”

Fed officials could ready their portfolio runoff plan but set an effective start date that initiates it after any debt-limit standoff has been resolved. “If we found ourselves unsure about the Treasury discussions over the debt ceiling, it could be that we make an announcement and then it’s got a little bit of a delay,” said Mr. Evans.